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Everything You Need To Know About Trading Options

Everything You Need To Know About Trading Options

If you're looking to be more proactive about your financial investments, you may want to consider buying and selling options. There is a misconception that trading options is complicated and should only be attempted by experts, but the truth is that anyone can do the research, learn the basics, and start trading. Here is everything you need to know to get started.

What Are Options?

Options are essentially contracts that give you the right to buy or sell a stock at a specified price during a set period of time. Depending on the type of contracts you buy or sell, options can be used to hedge your risk in the stock market or to leverage your money for a bigger profit. The two types of options are put and call options:
  • Put options give the holder the right to sell stock shares at a given price before a certain date. You generally buy put options if you think the stock price may fall, and you sell put options if you believe the price will rise.
  • Call options give the holder the right to buy stock shares at a given price before a certain date. You buy call options if you think the price of the underlying stock may rise before the expiration date, and you sell call options if you want to hedge against a price drop.

Why Would I Want To Trade Options?

Some investors like trading options because it can give them a big return for a small investment of money. Rather than needing the funds to purchase a big block of shares, you can buy and sell options, which are a fraction of the cost.

For example, if you notice unusual options activity and, thus, anticipate that a certain stock price will rise quickly, you can buy an option to purchase that stock at current prices. If the price does rise, as expected, you make money based on that growth. If it doesn't rise, your option expires without helping you make money, but at least the amount of money you spent was much less than the cost of the stock.

Alternatively, if you already own a portfolio of stocks, trading options can be a great way to hedge your risk and generate revenue. For example, if you own a block of 100 shares in a particular company, you can regularly sell call options on that block to generate income. As long as the stock price doesn't hit or exceed the target price, you keep the money from the options you sold even though the contract expires without any shares of stock changing hands. You are then free to sell another call option and generate additional income on the same block of shares. Some investors successfully use this strategy to earn a continual income stream on the shares in their portfolios.

How Can I Get Started?

To trade options, you need to open a brokerage account. You can use a full-service brokerage company or try a discount broker to save money on trading fees.
Trading options can be intimidating, but it doesn't have to be. The strategy is straightforward if you understand the basics, and it provides you with a tool to hedge your risk or make money based on the movement of stock prices.

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