When done properly, trading options is one of the most effective methods to make money over time. An option is a contract that allows an investor to purchase or sell an underlying instrument, such as a stock or even an index, at a certain price over a predetermined period of time. The buyers have to pay a premium to the sellers. This article shall walk you through the options trading basics and the top strategies to trade them.
Basics of Options Trading
Buying and selling options contracts on the open market is known as options trading. It is typically done on a public exchange. Options are more complicated than regular securities because they are derivatives. Their values depend on an independent underlying security or index. When comparing trading options to trading traditional securities, there are three important considerations to make:
- Pricing is very complex. Trading options requires monitoring a number of variables not seen when trading other assets.
- Since options trading involves leverage, losses are typically amplified to the same extent as gains.
- Trading long options positions is a short-term approach. So, retaining your investment usually entails a primary loss against a potential recovery.
Important Terms in Options Trading
Here are some key terms involved in options trading.
- Premium: The option premium is the amount that the option buyer must pay the option seller.
- Date of Expiration: The expiry date, often called the exercise date, is a date that appears on an option contract.
- The Strike Option: The striking price, also known as the exercise price, is the amount at which the contract is entered.
- The American Option: The option is tradable at any time up to its expiration date.
- The European Option: The option that is only exercisable on the day of expiration.
Common Options Trading Strategies
After looking at the principles of options trading, let’s examine the popular approaches used by traders. Some of these strategies are used for futures trading also. However, the difference between futures and options trading lies in the implementation of these strategies. Let’s discuss them in detail.
Long Call Strategy
Investors can probably start options trading with a long call strategy. This method is mostly used by investors for price speculation when they believe the underlying security’s price will rise in the future. More specifically, on or before the expiration date, the cost of that security must exceed the cost of the option premium.
Long Put Strategy
When an investor purchases a put option to represent his pessimistic view on an asset, it is known as a long put strategy. Additionally, puts are a popular hedging tool for investors who have long holdings in the underlying equity of the option. A long put strategy limits your losses to the amount you bought for the options contract and involves less leverage than a short sale. So, it is a less risky way to speculate on prices. In order to make money, the underlying asset must decrease on or before the expiration date below the premium’s cost.
Bull Call Spread
Investors who are confident in the bullish potential of an underlying asset but wish to limit their downside can adopt a bull call spread strategy. This is accomplished by writing (i.e., buying and selling) call options at the same time. The written call option should have a greater strike price. However, both options should have the same expiration date.
Bear Put Spread Strategy
When a trader or investor believes that the price of an asset or security will marginally drop, they will utilise a bear put spread. A bear put spread is created by buying Put Options and selling an equal amount of puts at a relatively low target price on the same asset. It will have the same expiration date. The maximum profit a trader may make is represented by the difference between these two strike prices minus the total cost of the options.
In contrast to the earlier methods covered above, a straddle strategy necessitates both a put and a call. Investors who anticipate volatility in the underlying asset but do not wish to speculate on the direction of price movement employ this method. Purchasing calls and puts on the same underlying asset with corresponding strike prices and expiration dates allows for the execution of a long straddle.
An investor or trader can purchase or sell stocks, ETFs, and other securities at a certain price and by a specific date with the use of options trading. If done correctly, options trading may yield profits that are multiplied. The full-time activity of options trading gives you the opportunity to earn extra money. However, you must have a well-defined plan. In addition, ensure to trade on the best trading app In India. You should go with platforms offered by reputed firms like Kotak Securities. The firm offers all the necessary trading indicators and chart patterns. This shall make trading options convenient for you.