Options trading may seem complicated to beginning investors. However, options are a great way to safeguard against risk while providing more ways to profit than stocks allow. While some kinds of options trading strategy can be a bit daunting, many are accessible to a range of investors with varying levels of experience.
In essence, an option is a contract giving the owner the right to buy or sell an asset at a certain price for a specific amount of time. The object being bought and/or sold can be a stock, ETF or index, but unlike stocks, options do not give the owner a stake in the company. Instead, it should be thought of as more of a contract that provides the potential for ownership if the guidelines are exercised properly.
While stocks restrict the owner to buying and selling, options provide different options trading strategies that can be bullish or bearish, used for hedging, or speculative based on time value, volatility or interest rates. The most common way to trade is through the standardized options contracts listed by futures and options exchanges. Listings and prices are continuously published on these exchanges, enabling individuals to determine prices and settle transactions. Alternatively, over-the-counter (OTC) options contracts are traded between two independent parties, as opposed to exchange trading. OTC trading enables the users to customize the terms of the option contract.
There are four basic types of traded stock options: long call, long put, short call and short put. A trader who is under the impression that a stock’s price will increase could buy a long call option, as opposed to the stock itself. A long put is used when a trader believes a stock’s price will decrease and buys the right to sell it at a fixed price. A short call is employed when a trader sells a stock short because he believes its price will decrease, while a short put is a bullish options trading strategy in which a put is sold to lock in the purchase price of a stock. These four types of trades come into play in options trading strategy, which can be simple or incredibly complicated, depending on the number of trades to be combined.
For example, one simple, well-known strategy is the covered call in which a trader buys a stock and sells a call option to collect premium up front. If the stock trades relatively flat or falls, the option will expire worthless and the trader can keep the premium. However, if the price of the stock rises above the strike price of the option, the option will be exercised and the shares will be called away, capping the trader’s profit.
There is an options trading strategy for every market trend. InvestorPlace offers the best options trading information to help ensure your investment success. Check out the “Options Trading” section of our website or sign up for the OptionsZone Insider to have the latest options trading news and articles emailed directly to your inbox today.