Options contracts are a financial tool designed to give investors the right to buy an underlying asset
at a predetermined price before or on a future date.
While investing in options contracts can be profitable, there’s a lot of risk involved because they’re leveraged trades.
Throughout this article, we’ll help you get to grips with options contracts.
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| What to Know Before Trading Options Contracts: eAskme |
Understanding Key Terminology
Options trading comes with a steep learning curve full of important terminology, which is essential to
understand before attempting to navigate the environment.
Some of the most beneficial terms to learn include:
Strike price: The price of the underlying asset set by the holder.
Expiration date: The last day the trade can be executed.
Call option: Gives holder the holder the right to buy an underlying asset at a given price.
Put option: Gives the holder the right to sell an underlying asset at a given price at a later date.
In-the-money: When the strike price is below the market value of an underlying asset.
Out-of-the-money: When the strike price is above the market value of an underlying asset.
Premium: The price the buyer pays the seller.
Assignment: When a seller of an option is obligated to buy or sell at the underlying price.
Intrinsic value: Difference between the strike price and the market price of an in-the-money asset.
Time value: Value not determined by intrinsic value (decreases as expiration nears).
These are only a few terms to get your head around, so it’s worth reading through additional
educational content to make sure you fully understand how options work.
There are countless blogs, websites, and YouTube channels dedicated to all things trading.
However, we recommend reading through content written by a professional like James Cordier, a commodity investor.
Exploring Different Trading Strategies
Like any other type of investing, success with options trading relies on forming and sticking to an
effective trading strategy, which should be aligned with your goals and style. Some of the most
common strategies to explore include:
Covered call: When a seller owns an asset and wants to sell it at a predetermined price. For
example, an underlying asset worth $47 could be sold for $50 through options contracts.
Bull call spread: Investors buy several calls while selling the same number of calls at a higher
price.
Married put: Investors with long-term positions in stocks buy in-the-money put options to
defend against market depreciation.
Protective collar: Buying a downside put and selling an upside call is designed to defend against significant losses
These are just a few of the many tried-and-tested options trading strategies. When you’re deciding
which route to take, consider your risk tolerance and investing goals.
As well as this, remember to conduct plenty of research.
Methods of Managing Risk
Options trading involves leverage, which makes it a much riskier trading landscape.
Fortunately, there are plenty of ways to manage risk and reduce losses. For example, the majority of options trading platforms allow you to set stop-loss and take-profit orders, which withdraw positions at a
preset loss or profit, respectively.
Diversification is another way of managing risk, and it’s not only applicable to options trading. This
risk management technique involves investing in different markets and assets to reduce risk.
The theory is that while one market is depreciating, there will likely be another appreciating.
Many readers use hedging strategies to reduce losses by offsetting positions. For example, if you own
a call option for an asset, you can sell a put option for the same stock to hedge the risk.
General Tips for Beginners
Options trading is overwhelming for beginners because there’s a lot to learn and plenty of risk
involved, but it can also be rewarding if you’re willing to follow these tips:
Educate yourself: Learn about the risks and rewards by taking online courses, reading books,
attending webinars, and following experts on social media.
Start small: Limit loss by starting small - you will make mistakes at the beginning.
Use a demo trading account: Demo accounts allow you to practice strategies without risking
cash assets.
Use stop-loss orders: Prevent missed opportunities to withdraw by using stop-loss orders.
Don’t chase losses: If you lose money, don’t try and make it by immediately placing another trade. Take time and follow your trading strategy.
Be patient: Trading takes time to learn, so don’t expect to make a fast fortune. Options trading can be rewarding, but it’s also a cruel mistress welcoming plenty of risk.
If you spend time learning the landscape and practicing strategies, the rewards will eventually outweigh the losses.
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