Prior to starting options trading, there is a lot to learn. When you learn how to properly assess your risk, options can come with significant benefits for your portfolio. Let’s explore how to get started in this type of trading.
What Options Are
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Options are a type of contract that allows you to buy or sell a stock at a set price on or before a predetermined expiration date without any obligation. Long-term options tend to have an expiration date that’s over a year from the start date while short-term options typically last under a year. Like mutual funds, bonds, stocks, and exchange-traded funds (ETFs), options are a kind of asset class. They fall into a group of derivatives, meaning that their price is linked to that of something else.
There are two varieties of options: call options contracts and pull options contracts. Call options give you the right to buy while pull options give you the right to sell. You would choose a call option when you expect a stock to rise. This way, you could buy it for a lower price than it’s worth. You would choose a pull option when you expect a stock price to fall so that you can sell at a higher price than it’s worth.
3 Steps for Trading Options
Follow these steps to start trading options:
- Research brokers. You want to find a broker who can help you make smart investment decisions. Screen multiple firms to ensure that they are going to give you the customer service you deserve.
- Open an options trading account. To do this, your broker will first ask you questions about your financial information. Then, they will assign you to an appropriate initial trading level.
- Talk to your broker. You both can look at where the stock is going and the time frame of your option. They can provide you with research and resources to make your decision. Make sure you both assess the risk of the options.
- Be patient. Once you choose an options contract, it may be wise to wait and see what the stock does.
Options Trading Terms You Should Know
Every options trader should know these terms:
- The Greeks: These are measurements that help you assess the risk of an options contract.
- Delta of an option: The impact of change of price of an underlying asset.
- Gamma of an option: Delta’s rate of change.
- Theta of an option: The impact of a change in time remaining.
- Vega of an option: The impact of change in volatility.
- Strike price: The price you can buy or sell your stocks for on or before the expiration date.
- Exercise: When you move forward with the right of your option. Meaning that you decide to honor the put or call contracts.
- Expiration: When you can no longer exercise your option rights.
Once you get started in options trading, you may soon see the benefits of such an investment. The key to making smart investments is to be an educated options trader.