It is not uncommon for investors to shy away from options trading due to a lack of understanding of the concept. To help people with no previous experienced in understanding the basics of options trading, here are some of the key factors that anyone needs to be comfortable with before getting started.
It is a Contract
Options trading is not trading in actual stocks but rather in contracts that create the opportunity, but not the obligation, for an investor to choose to buy, sell, or allow the contract to expire. The contract itself is on an underlying or supporting instrument. These instruments are typically an ETF (exchange-traded fund) or a security, but they can also be an index, which is bought and sold based on a period of time and a price that has been predetermined. In other words, the contract provides the price to buy or sell within a specific period of time. If neither happens, and no action is taken, the contract simply expires.
Strike Price and Strike Date
The strike price is the pre-set price at which the buyer and the seller agree that the underlying stocks will be sold within the specifically stated time of the contract. The strike date is the date of the contract to buy or sell.
Calls and Puts
With options trading, it is possible to both buy and sell at the strike price. In order to distinguish if the strike price is to buy or sell, these types of contacts are called call (buy) or put (sell) options. For example, if you have a call option for a stock at $100 on a specific date, and the market price on those stocks is $125, the trader can buy the stocks at the predetermined price of $100 and sell them for $125, making a $25 profit. On the other hand, with a put (sell) option, if the price of the stocks drops down to $90 on the strike date, and you have a put option at $100, you can sell at that price, which provides you with a $10 profit. Choosing between a call and put option depends on how you anticipate the stocks will move. As this can be complicated, working with our stock advisory service can help you to learn the basics and move to more advanced investment opportunities in the market. Click here to learn more about Options Trading Concept.