The Basics of Options Trading
Options trading is a popular form of investment and an astute trader can perform quite well should he or she be aware of some of the basics. So, let us have a quick look at what an option is and how it is used in market trading.
Essentially, the owner of a stock has the right (but not the obligation) to buy or sell this position at a certain price on or before a specified date. There are two main types of this instrument that are known as a call and a put. A call gives the trader the right to buy a position for a certain period of time. A put gives the trader the choice to sell this position. This type of investment can be used for various types of equities and likewise, the trader can assume varying levels of risk that will include but are not limited to the time an option is held, the potential loss involved and naturally, economic conditions.
To recap what can be a confusing topic, an option on the stock market involves these characteristics:
- The right to buy or sell a position for a certain price within a specific time.
- An option can either be a "call" or a "put"
- Thee positions can accommodate varying levels of risk and strategies.
Although an option can be seen as a means to mitigate the volatility of the open market, there are still some considerations that need to be appreciated. The first will involve the type of equity one is involved with. Each equity has its own level of risk. For example, options trading that involves a currency may be subject to quick fluctuations following the release of international financial data. Relationships between currencies can fluctuate and money can be quickly made or lost. The longer the position, the more risk involved.
Additionally, it may be difficult to know when to execute a trade. For example, if one has a put option on gold and recent economic data may indicate a flagging economy, he or she may wait to sell. However, if the strength of the dollar rises, vast amounts of gold may be sold and the price could subsequently plummet.
A third variable is the fact that some positions are inherently safer than others. An illustration of this is what is known as a binary trade. As opposed to waiting for a position to reach a certain level, binaries allow the holder to predict which direction the price will go (up or down). If guessed correctly, a profit is accrued. This is a relatively safe position (assuming the individual understands how a binary option works) as opposed to a situation where a more liquid trading position is taken and the price could go either way quickly. Once again, currency trades are an example of this.
So, some things to consider with this type of stock market investment are:
- The type of equity and current economic conditions.
- The knowledge of when to close a position.
- The relationship of risk involved with a given position.