Options trading is becoming increasingly popular among investors. It’s no longer just the professional traders who are involved as more and more home traders and casual investors are taking advantage of the benefits of trading options.
What Does Options Trading Involve?
Options trading involves buying and selling options contracts on public exchanges. It works like stock trading. Whereas stock traders make money by buying a stock and selling it at a higher price, options traders earn a profit by buying an option and selling it at a higher price. However, options trading is much more flexible compared to stock trading. Options contracts can be based on a wide range of underlying securities such as indices, stocks, foreign currencies, commodities, among other things, giving you far more opportunities for potential profits.
Buying an options contract is no different from buying a stock. You’re basically taking a long position on that option, believing that its value will increase. You can buy an options contract by simply choosing exactly what you want to buy and how many, and then submit your order to your broker. If your options increase in value, then you can either exercise your option or sell them.
The good thing about options contracts is that you can buy them in situations when you expect the value of an underlying security to increase, and also in situations when you expect the value of the underlying security to decrease. If you expect the value of an underlying security to go up, then you would buy call options, which allows you to buy the underlying asset at a fixed price. If you expect the value to go down, then you would buy put options, which allows you to sell the underlying asset at a fixed price.
Selling and Writing Options
You can sell options contracts either by placing a sell to close order or by placing a sell to open order (writing options). You would usually use the sell to close order if the value of your options has increased and you want to take your profits at that point, or if the value of your options has decreased and you want to exit your position before you incur any other losses. You would usually place a sell to open order if you think the value of relevant underlying security wouldn’t change in such a way that the holder would be able to exercise his or her option to earn a profit.
The ability to create options spreads is what really makes trading options an interesting way to invest. While you can make money trading through buying an option and selling it if you earn a profit, it’s the spreads that provide you much more opportunities to make serious money. An option spread is created when you simultaneously buy and sell options of the same class on the same underlying security but with different expiration dates or strike prices.
If you want to trade options, you will have to work with a brokerage firm that supports options. Keep in mind, however, that each platform is unique and has its own benefits and drawbacks. Thus, it’s best to clearly define what you want in an options account and platform before you get started.