Some investors who would like to learn about options investing may be intimidated by the vocabulary and uniqueness of this trading vehicle. However, a basic guide that can explain options in plain English like a trading options for dummies article could help the individual see that learning options trading doesn’t have to be scary.
Unlike stocks and other investments, options are like contracts. The buyer of the option is buying the right to buy or sell the underlying security at a given price called the strike price.
Call options give the buyer the right to buy the underlying security. Put options give the buyer the right to sell the underlying security at the strike price.
If the buyer is going to exercise the option, the buyer must do so on or before the expiration date of the option. A buyer has a choice to exercise the option but is not obligated to do so. A seller must follow through with the terms of the option if the buyer exercises the option.
The underlying security of an option may be a stock or other commodity. An option covers one hundred shares of the underlying security.
An option premium is the price paid by the buyer to the seller for the option. The option quote includes the price of the option as one share so it must be multiplied by one hundred to be the total price for the option.
The price of the option is influenced by the value of the underlying security compared to the strike price, the volatility of the value of the underlying, the time left until the option expires, and other factors. As an option gets closer to the expiration date, the value of the option based on time diminishes.
An option quote also includes the expiration date of the option. If the buyer does not exercise the option, the option expires as worthless. Then, the seller of the option keeps the premium as a profit.
Options traders use different strategies depending on their goals for trading options and their comfort with risk. Some strategies do not involve as much risk as others.
However, all options trading involves some risk. Investment brokers have disclaimers on their websites warning potential investors to only use risk capital to invest in options.
Some options strategies only risk the premium paid for the option plus the broker fee for the trade. An investor should use a strategy that does not have more risk than what would be comfortable.
Options investors can learn options trading strategies from articles and other resources. Many options investors begin by buying a call option which is a very basic option strategy.
When an investor wants to make an options investment, the investor places an order with an investment broker. The broker finalizes the investment with one of the options exchanges which are similar to stock exchanges.
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