Trading stocks and shares have never been easier, and both of my sons are extremely interested in stocks and options trading. Not only are the tools and platforms that you need to start trading available for free, but an investor can get started with relatively little cash. However, before you get serious about investing, it is important that you understand what you are getting into. Misunderstandings can have tragic consequences where your finances are concerned, so before you start trading options, make sure that you understand the basics.
What Are Options?
Before you dive into the world of options trading, you need to know what options are and how they differ from other types of trade you might have made in the past. An option is a contract where the trader can buy or sell an asset at a set price on a specific date. When the contract is to buy an asset, it is known as a call. When it is to sell an asset, it is called a put. A ‘stock option’ is usually a contract for the sale or purchase of 100 shares worth of stock. However, the terms of an options contract can vary.
Why Do Investors Choose Options Trading?
The primary reason for an investor to buy an option is because they want to be able to take advantage of the current market price. If they suspect that the value of the underlying assets is likely to increase or decrease significantly in the near future, then buying an option on it means that they can buy or sell the asset at its current price at a future date. If the investor’s prediction is wrong, then they are only on the hook for the cost of their options contract, not the difference between the expected and actual value of the asset.
Many investors also use options to hedge their existing stock against potential losses. Let’s say that you own stock in a company. If you are concerned about the short-term volatility of the stock or you think that conditions in the near future look difficult for the business, you can use an options contract to give yourself a potential out. Buying a put option will enable you to sell your shares at the current market value at a future date, even if the stocks have tanked in the meantime.
Puts And Calls
Both the put and the call have their use in the investors’ toolkit; we have already touched briefly on a few of them. Before you start trading options, it is absolutely essential that you understand the difference between the put and the call; you need to know which one you are going for every time.
The put is used to sell shares. The call is used to buy shares. Think of it in terms of whether you want to put shares on the table, as in selling them, or you want to call in other shares and buy them. Whatever helps you to remember the difference is fine, just make sure that it is clear in your head.
Whether an investor buys a put or a call, they are not obligated to execute the trade specified within. This is why options are a popular way for investors to hedge their bets. An investor might want the option of investing in a business at the current market rate, but only if the business can prove itself in the meantime. A call would give an investor the option of purchasing the shares in a year at their current value. If the business has been successful in the meantime, the shares should be worth more now. If not, the investor can walk away.
Now that you know the fundamentals of what an option is, you need to find a platform to trade on. This is something else that you need to think carefully about, make sure you research thoroughly and start cautiously.