Options trading is an easy and effective way to make your investments grow. However, like every trading method, options trading has its own peculiarities.
To begin with, options trading is a type of financial contract whose value depends on an underlying asset (individual and group) or a benchmark. The contract gives buyers the option to buy or sell a security at a price that has been chosen and at a time in the future.
As a beginner, it may seem daunting. It may seem challenging to get the hang of calculating options profit, drawing potential forecasts, paying a premium for options trading, and determining the right time to enter such trading. We discuss everything a beginner should know when starting with options trading.
4 Things Someone Starting With Options Trading Should Know
- Buying Calls (Long Calls): Options trading allows traders to stay in control of the direction they are moving in the market. If your research and analysis show that the price of an asset has the potential to rise, then you can opt for a buy-call option by using less capital than the asset itself.
In an occasion where the asset price falls, it will not fall beyond the premium price paid. Options allow traders to use smaller amounts to increase their upside benefits. Such an option is particularly great for traders who have a confident approach to a stock, index, or exchange-traded fund.
- Buying Puts (Long Puts): Buying a put option gives the holder the feasibility to sell the underlying asset at a set price. On the other hand, a call option gives the holder the feasible option to purchase the underlying asset at a price that has already been set before the expiration of the contract.
With buying puts, if the underlying asset hits the higher than option’s strike price, the option will end up expiring. Whereas, during a put, the option gains value as a result of the underlying asset’s price decreases. Short-selling allows a trader to take advantage of falling prices.
The drawback is that as the short position is unlimited, there is no limit to where the price can rise. It is vital to take necessary and cautious steps to ensure that your investments are making consistent progress and not merely expiring.
It is ideal for people who are looking to make the most out of their short-selling strategy and people who want to take advantage of the falling prices.
- Covered Calls: This type of strategy is overlaid onto an already existing long position. The upside call is sold at an amount that can potentially cover the position and size of the existing position. Through this, the option premium is collected as an income.
There is a limit on the upside potential associated with the underlying asset position. In the covered call strategy, the trader sells the call, and the option’s premium is collected. This results in a lowered cost on the basis of the shared.
Downside protection is proposed and provided as well. By selling the option, the trader sells shares of the underlying asset at the option’s strike price. This eventually caps the upside potential.
This option is viable for traders expecting no change or looking to collect the full option premium.
- Protective Puts: The protective put is the practice of buying a downside put at an amount that can cover a position existing for the underlying asset. This strategy lowers the chance of any further losses.
The options’s premium at such junctions acts as a protective layer against losses. Such a strategy is highly utilized by traders with any underlying asset looking for downside protection.
Parting Words For New Traders…
Being a beginner can seem challenging initially, especially when you are getting used to the terminologies, methods of keeping a market watch, and options trading strategies. It may initially seem overwhelming. However, it is essential to have a strategy in place that ensures you can protect yourself from losses.
Options trading is highly preferred by traders who have a specific stock preference or want to be sure that their investments do not exceed a certain limit (in this case, the option’s premium). Be sure to take your time making decisions instead of jumping into making haste decisions.