Lately, you may have become interested in options trading. You are not alone in this, in fact options trading has become more popular in recent years. It hit an all-time high in 2020 with an incredible 7.47 billion contracts. This is a whopping 52.4% more than the previous year, this is due to the results Option Clearing Corporation. Whether you’re an experienced investor or just getting started in the game, both options help options trading reach new heights.
According to some, option trading can be a good thing. It may increase your income, it may limit your risk. In addition, you can immediately hedge against market fluctuations. In some places, such as a brokerage house First road offers options trading with zero fees, zero fees for option contracts and no fees associated with deposits, inactivity or maintenance. All of this in your portfolio can give you more options than just stocks. Options can also act similarly to an insurance policy. How it works, for example, if your stock is declining, buying niche options can help eliminate losses you could potentially incur.
Options can lower the breakeven point and also allow you to set the price of a stock below its current market price. But options trading is not always an easy job. You need a strategy with your participation.
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What is an option?
But let’s not get too ahead of ourselves. Let’s take a step back. What is an option? An option is a contract that gives an investor the “option” to buy or sell any particular stock at a certain price within a certain period of time. When the time period ends, the option expires, it no longer exists and has a value of zero. It should also be noted that one who works within this caliber is under no obligation to buy or sell. Options also have no idea of ownership of the company they are in. Since it is technically a contact, it only represents the possibility of ownership.
There are two kinds of options.
- Call Options: These allow the buyer to have the right to buy a certain number of shares, usually limited to around 100 shares. Complete this anytime before the contract expires.
- Put Options: This allows the buyer to sell a certain number of shares. This can also be done at any time before the expiration of the contract.
Another thing to note is that although these options have a long expiration date, as they get closer to expiration, their value starts to decline. When the market is volatile, this can also increase the risk for the investor, since the option may have little value as it approaches expiration.
Options trading is also known as a risky game due to the complexity of the whole process. Besides, how difficult it can be to understand. That’s why it’s better to understand how it works before getting involved. You want to know what you are doing with your money so you don’t lose it.
The risks generally depend on your own role in the contract. Whose side are you on and what strategy are you going to use. Strategies can be based on how much time is left, market volatility, and even interest rates, all of which affect option trading.
But the good news is that you can lose a small amount up front if the trade goes against you. Given how intense option strategies are, you may notice that some brokers will have extremely strict rules and powers that require investors to comply.
Should you trade options?
Now the question is, is it right for you? Well, it all depends on what idea you have to put into practice before you get into options trading. A good start would be to do some calculations to find out what your maximum profits and losses are. Also, what are the break-even points of the strategies you plan to use. There are certain types of options trading calculators that can be used online.
When you’re ready, you should look for a broker with a low contract fee for options. Also, learn what resources you’ll need to help you navigate the strategies you’re about to lose. An option for a beginner would be Robinhood as they offer commission-free option trading as well as zero-commission stock trading. However, it does not offer the more interesting options and research opportunities that the big brokers are able to do.
Now that you have a beginner’s idea of what options are. You can take this new knowledge and decide for yourself what you want to do with it. Good luck!