What is Options Trading | Basics Of Options Trading Explained

What is Options Trading | Basics Of Options Trading Explained 

It is important to understand what stock options are and how they are used in the normal market
of stock trading if you are intent on becoming an investor for the long haul. Owning and
exercising the right stock options can end up saving you money in the long run when you are
positioning your investments for long-term gains.

On the other hand, those who use options as an income producing instrument need to be
careful when participating in the options market. Options are among the most risky of
speculative investment vehicles. And while great gains can be made in the options markets,
the converse is also true, great losses can occur.

So, just what are stock options? An option, also known as a derivative, is a binding contract
that gives the buyer the right to buy or sell an underlying asset at a specific price on or
before an expiration date without any obligation to do so. Just like a stock or bond, they
are securities, and are called "derivatives" because they derive their value from an underlying
asset.

There are two basic types of options being traded at any given time. The first is termed a
"call" which gives the holder (the buyer) the right, without any obligation, to buy an asset at
a stated price within a defined period of time. The second is termed a "put" when traded,
and it gives the writer (the seller) the right, without any obligation, to sell an underlying asset
according to the same parameters.

Trading stock options online can be a powerful method of increasing returns due to their
versatility. In this case, though, the power comes at a price. Option trading can be very risky
and potentially dangerous. Options use leverage to control many shares of stock at only a
percentage of the stock's actual price, and small price movements can result in large gains.
However, if an option expires before the stock rises in price, all of the investment (the price
of the stock option itself) can be lost.

Options are popular both from an investor's standpoint and from a speculator's position
because they can help the investor or trader get more bang for his buck. Instead of having
to buy a stock outright, the investor can enter into an options contract which can be less
costly while having the same – or even better – result.

An investor can shield his portfolio from market downturns or take advantage of upturns
through the use of options. One way he can do this is to purchase a stock option during a
price drop. This allows him to sell his shares at a pre-determined higher price than the
corresponding drop in price. Conversely, he can purchase an options call at a predetermined
lower price while a stock is at that lower price and then exercise the call as the stock price
rises, paying less per share for the same amount of stock.

The trader who speculates in options can use the option itself as a vehicle for profit. Through
buying a call at a lower price, he can take advantage of a price rise in the underlying stock
and thus the value of the option he bought also rises in correspondence to the stock,
producing a profit situation. The same can be done in reverse using a put option.

If you plan on trading options at some point make sure you fully understand the risk and
downside of each trade. This is where a sufficient knowledge of stock option investing
becomes an invaluable asset in one's market education. Trading options is not for everyone,
especially if you are not comfortable taking on risk or managing positions. If you don't know
what you are doing, the market can be brutal and unforgiving.