What is Options Trading?

Options trading is when an investor purchases or sells a particular security at a given price on a stock exchange. Most professional traders have years of experience and perfected their skills using efficient strategies, whereas beginners may learn as they go. If you are a casual investor and considering options trading, it is significant to gain knowledge about these types of trades.

What is an Option

An option is a financial instrument contract and derivative based on the present market value of a security. An example is a company stock offered on a stock market exchange for traders to buy or sell. The difference between options and futures is that the security holder can choose when to sell or buy the stocks.

Types of Option Contracts

Call Option
Put Option

Call option is a contract providing the investor the right to purchase from stock market exchanges. The contract terms specify the number of shares of the stock, or the fund shares protected by the option contract. It allows the investor to buy the option at an itemized price within a stipulated timespan.

An investor who purchases call options on stocks expects the price per share will eventually rise over the base price before the expiration date. If the stock price increases over the base price, the investor has the option to purchase the option. Investors have the opportunity to buy the stock and sell it anytime for a profit at the present market price.

Their total profit is the difference between the market share price and base share price, minus any expenses, such as brokerage commissions. An investor who decides to sell a call-option is forecasting that the stock price will drop or remain close to the base price of an option. Sellers are referred to bearish and buyers as bullish when trading securities.

Put option is a contract giving the investor the right to sell an option to the Options Clearing Corporation or the Exchange Traded Fund. An investor believes the stock market price is going to decrease below the base price before or on the expiration date of put options. You can sell a stock at the stated base price per share by the required date on the contract.

Investors who buy put options expect the stock price to fall when the original stock's price is under the base price. You can employ the put, if the stock price is lower than the base price at the end of the contract. He or she will sell shares of stock at the option's greater base price. Profit on the trade is the present market price minus the base price, expenses, and fees.

Options Trading Strategies

Two strategies investors use for options trading are:

Bullish
Bearish

Option investors use the bullish strategy when they expect the basic stock price to increase. They use Theta with the combination of bullish and bearish, referred to as a calendar spread. It is useful when they expect the change is indirect. The most used bullish options trading strategy is purchasing a call option, for an instant.

Traders use the bearish options strategies when they expect the stock price to decline. Investors must assess how the stock can go and the timeline it will decrease. This assessment helps them to determine which trading strategy is effective. Bearish options for trading are a strategy involving a credit that requires the trader to open a margin account. The most used bearish option trading strategy is the put, to purchase or sell.

Professional and beginner traders are investing in options trading because of its versatility and benefits. They use options to add diversity to their investment portfolios and to protect against losses. Options trading can help generate income or it can cause investors to lose money if they make the wrong call or put on a security. Options investing has its benefits but can become risky when the market changes unfavorably and you don't have an exit backup strategy.