There are a few things that you need to know before you start options trading. You need to know what options trading is, the basic language you will find in the trading world, why people choose to work with options contracts, the different orders that you can use with options trading, and the way that options work.
Definition of Options
Options are a type of trade that is in contract form. The buyer of the contract is then able to sell the asset that comes along with the contract at a specified time for a specified price. Essentially, it’s a promise from one person to another to either buy or sell something at a given price, regardless of its real market price, at a certain point. The price does fluctuate both up and down when it comes to the total value of the options, as a response to the market price and the contract price. Because of this, you can be sure that you will almost always make a profit on the options if you know the right way to buy them and know the specific terms of the contract.
The biggest thing with options is that they do have an expiration date. If you do not have a chance to sell it off before that time, then you will lose your money because the contract is void.
Language You’ll Hear in Options Trading
Call option – This is basically a contract in which Person A tells Person B that Person B is allowed to buy commodity/stock C at price x, regardless of market price y, as long as Person B exercises their contract by expiration date d.
Put option – The inverse of a call option; Person A tells Person B that Person B is allowed to sell commodity/stock C at price x regardless of market price y, as long as Person B exercises their contract by expiration date d.
Derivative – the total value of the security that comes from the purchase amount and the assets that stand underneath the total value of the contract
Expiration date – the point in which the contract will expire, and it will then not be able to make any more money. If a contract holder does not sell the contract before that time, he or she will lose out on the money that was paid for the contract.
Long position – The person who is buying an options contract is in the long position. They have the option, though not the obligation, to exercise the contract by a given date.
Options contract – the actual contract that is purchased as an investment. It outlines the price, the value that is going to come and the expiration date of the contract at which point it becomes completely useless to the people who have the contract and who want to be able to sell it.
Reasons for Options Trading
The two biggest reasons that most people use options trading as their main form of investment are speculation and hedging. When it comes to these two particular niches, options fill them out particularly well.
The speculation part is easy. Options trading allows you to essentially bet that stock/commodity c will rise to price y by date d. If you buy the stock/commodity c at price x, and it rises to price y – which just happens to be $10 more than price x – then you gain a total of $10 per share/unit in profit, if you turn around and sell the asset/commodity instantly at price y. You get the $10 in profit per share/unit because the options contract allowed you the ability to buy the stock/commodity c at price x even when the actual market price was y. So, with options trading, you can assume that an asset or commodity is going to rise in value massively for some reason or another, and then get an options contract now letting you buy it at a set price later, so that you can turn a profit simply selling the asset or commodity at market price.
Hedging, on the other hand, is one of the lowest risk tactics in options trading. The people who use hedging are able to get more out of the experiences that they have because hedging provides an assurance that their money will be safe. The options that you purchase will only be available so that you can reduce the amount of loss on your investments. If you are going to hedge with options, you need to make sure that you are doing it in combination with other stocks and trading options that you have.
How it All Works
If you have a contract that has different guarantees on it when it comes to finances, you will be able to use that contract to make sure that you are going to get more money from the various assets and commodities that you’re working with. The market price of a stock that you have may be at a certain point at any one point in time. Then, the price may go up. Depending on what the options contract was written with, the price will go up with it. The contract is usually worth 100 times the rise in the stock because it is 100 shares worth of that fund.
For example, if you have an options contract that says you have 100 shares of a stock for company X, then when the price of the stock rises for company X, so does the value of your options contract. If company X goes from a value of $10 to $18, then your contract will also go up by eight points. Because you have 100 shares within that contract, it will actually be worth $800 more.
Orders for Options Trading
When you have an options contract, you will need to create some orders that will tell your broker to do specific things. These can be things like stopping the options from losing too much money or simply limiting the amount of money that gets spent on the options. If you know which order you want to use, you will be able to make sure that you are going to truly be able to have your broker do the best work possible.
Limit orders give your broker the price that you will buy or sell for.
Stop limit orders will limit the way that you are able to change your money around between different options trading contracts.
Market orders tell your broker to only act if the options stock is at a specific market price.
Stop market orders do the same as stop loss, but they are based on the market value of the options stock.
Stop loss orders are just like any other type of stop loss. You tell your broker where you want to stop losing money at.