An option is a conditional derivative contract written by a seller that gives the investor the authority to sell a share or security at a specific price in the future.
To grant such rights, the seller charges the option buyers a premium.
Generally, there are two categories of options, ‘call’ and ‘put’ options. A Call option provides the contract buyer with the right to buy the security in the future at a predetermined price called ‘exercise or strike price.’
The Put option gives the contract buyer the authority to sell the underlying security at a predetermined price in the future.
There are two other types of options: American and European. You can exercise an American option at any date until the expiry date. A European option, on the other hand, can only be exercised on the expiry date.
Options trading allows you to buy or sell stocks, securities, exchange-traded funds (ETF), commodities, etc., at a specific price within a pre-decided time.
In short, you trade in options rather than usual shares. You can perform options trading effectively using alpaca api.
Why Should You Trade In Options?
In the past, options trading has been thought of as a complex and sophisticated concept to understand. But the reality isn’t like that.
If you know how to adapt to the current market trends and price movements by implementing the best strategies, it can prove to be a great complement to your investment planning and trading strategy.
Here are some reasons that make options trading a lucrative way to make money:
Options provide you leverage on investment. Usually, an investor gets cheaper exposure to a share without even actually buying it. It allows him to hold a position similar to the share position, but at a lesser cost.
Trading in options can reduce the overall risk in your portfolio if you take the right call at the right time.
The financial demand in options is lesser than that for equities. Moreover, options show a similar characteristic to hedge funds and make for safer investments than stocks.
The costs incurred by investors while purchasing options are less. Thus, the returns generated are usually higher than their equity counterparts.
Options are a potential source of portfolio income. By selling options, you get entitled to receiving payments even if they go unexercised.
You can target an options trade in an extensive range of instruments like interest rates, index products, foreign exchange, metals, fuels, etc.
It provides you with much more flexibility and agility to trade despite current market situations in one domain. Thus you get the advantage of trading at any given time across markets.
Due to the quick execution of placed orders and transactions, there is a regular flow of liquidity among traders in the market.
Unlike stock trading, your money doesn’t remain stuck in one place, enabling you to re-invest in rising market opportunities and make profits.
Some Risks Associated With Options Trading
Like any other trading method, this one also comes up with some risks and limitations. Before deciding to trade in options, you should be aware of these risks:
Since options are a highly-leveraged form of investments, instantaneous price movements are expected within minutes or seconds. Thus, it becomes quite crucial to time the trade accordingly.
Challenging For New Traders
Options can be a complicated arena to get hold of, especially for beginners. Usually, skilled and experienced traders with alternative strategies to adapt to market volatility make profits.
But if you are a rookie, there is hope – quick learners can try the following strategies to strike success.
Best Options Trading Strategies To Get You Higher Returns
Nearly every strategy affiliated with trading in options is based on these two fundamental options: calls and puts. Here are some popular strategies you must know before investing in options:
The trader buys a put hoping that the stock price would be below the strike price before the expiration. It can be a good strategy when you are expecting the stock price to fall.
The trader buys a call anticipating that the stock price would be above the strike price before the expiration. If you think that the stock can move much higher, then this strategy is good to go.
If the trader sells a put expecting the stock price to be higher than the strike price by expiration, that means the ‘short put’ strategy is in action. Here the maximum payment a trader is entitled to be the premium.
This strategy involves purchasing a hundred shares of the underlying stock and selling a call option against those shares.
It is a good strategy when the investor owns a share and anticipates its price to remain stagnant till expiration.
In this strategy, the trader buys put options for an equal number of shares after purchasing a stock.
The trader fears the stock price may fall in the short-run but wants to hold it for an extended period expecting a significant price rise.
Here, the trader buys both call and put options simultaneously, having the same strike price and expiration date.
This strategy is effective when the stock is looking volatile, and one cannot determine the direction where it is heading.
This one is similar to the long straddle strategy, the only difference being different strike prices. Traders must ensure that the put strike price is lower than the call strike price.
The key to success while trading in options depends heavily on your approach, market-ready strategy, risk-appetite, and management.
The best practice is to put just 3-5% of your trading funds into each trade. This way, you won’t end up blowing your whole account, even in a worst-case scenario.
Learn to read the market and respond with a sound plan to earn profits. Since market data plays a crucial role, consider using a stock quote api to research and analyze market trends.
There are plenty of strategies and advice available all around. But the trader is the only one responsible for his investment.