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Options Trading Guide: How to Trade and Different Options

Options Trading Guide


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Options trading is a common term that is used these days in the share market and in news channels. But what options are? That must be really confusing for you, right? But don’t worry, in this article, we are going to discuss the very basics of options trading, know the keywords around it, advantages, disadvantages and risks of options, types of options trading,  puts and calls options and about how you can earn money from options and which stocks will make you money in options trading. Sit tight cause this article is going to solve all your doubts regarding options trade and at last you will know the basics and how to earn money from it. So let’s dive right into it and discuss the basic definition of options trading:-

What is Options Trading?

Options trading is basically having a contract to buy and sell shares but it is not obligatory to do it. The contract comes with a specific time period before which we have to buy or sell shares.  You can purchase options like any other asset by using a broker investment account. Options boost traders portfolios by added income, even leverage, and protection. 

Options trading is suitable for investors goals, but you have to look into the current situation and observe before you put money into it. A popular example for the option is to hedge against a falling market so that a trader can limit the level of downside loss he or she is about to face. Options are also used to generate income occasionally. it will work as a side income or pocket money that you generate part-time. 

It helps you to improve your financial position with less stress and last but not least, options trading is also used for the speculative purpose means you can use this to predict the movement of market and stock in the short and long run. This helps you give a better position in the market and helps you to make decisions regarding whether you should buy, sell or hold the position. This is beneficial for every trader whether it is a new trader, intermediate or advanced trader. All these features help you increase profits and reduce risks and loss and it works perfectly with investing goals.

What is the Call and Put Option?

Options are secondary security and it is secondary because the price is linked with some other factors. When you buy an option contract, you have a right to sell or buy all the basic asset classes before the expiry date.

In the Call option you get the right to buy the share and in the option, you get the right to sell the share before the expiry date.

The put and call option can only be used as hedges because they are used to limit all the losses and increase all the gains. A call option is used to hedge against the falling price of the asset, while the put option is used to hedge against the rising price of an asset. The call is used by short sellers to hedge against their position while a put option is not used by short-sellers as the gains are limited as the price never falls below zero.

Calls can be used to hedge against the falling purchase power, while put can be used to hedge against the increasing sell price.  Traders also use the call option to hedge against falling dividend payments, while the put option is used to hedge against falling native currency for payment. There is unlimited gain and loss of premium for call buyers, and there is limited gain and loss of premium for put buyers.

What types of Options Trading are available?

European and American Options:-

European and American Options don’t involve geography but it involves early exercise. In the stock market, many options are European style because the right to early exercise got some value and others are American style options as they have a high premium as compared to European style options because the early access option is up to you as it has high premium and that’s the only thing that distinguishes American style option from European. Expect that they are pretty much identical.

Long term and short term options:-

Time ends quickly for short term trade because the duration is small in short term options but in the long term, the time exhausts slowly as the time duration is longer as compared to short term options. It can be for a few years or even a decade. Risk in the short term option is that you hold for a short period of time while the risk in the long term option is that you have high leverage which magnifies your loss. Short term options are cheap as compassion to long term options.

Long Put/Call

Long put and call is the easiest option.  In this position, your downside loss is limited to the premium spent. You create a staddle if you continuously call and put options at the same expiry date. If the underlying prices fall to rise dramatically, then the position will pay off. You will lose premium on both puts and calls if the price remains stable and there is no change in it. If you know the price will move only in a certain direction, then you will enter this position.

 You don’t have to know which direction. In this strategy, you need the stock price to move out of the price range. There is the same strategy where you put money when there is a huge movement in the asset class and the market is volatile. You have to buy calls and put options simultaneously with a different expiry date. The strategy is called strangle. In Strangle, you need price movement in either position to gain profit. This strategy is cheaper than a straddle. If you do short in both straddle or strangle, you will profit only if there is low movement in the market.

The Spread:-

Combinations are trades constituted of both a call and a put. There is a unique type of combination known as a “synthetic.” The argument behind synthetic is to bring about an options position that acts as an underlying asset but without actually inhibiting the asset. Why not simply purchase the stock? Maybe some legal or regulatory reason inhibits you from owning it. But you may be permitted to create a synthetic position utilising options.

Pros and cons of Options Trading?

There are advantages and disadvantages of everything in the world. Let’s discuss some advantages and disadvantages and find out if options trading is beneficial for you or not.

Advantages

  • There is a huge leverage power in options trading. You can buy options at a really low cost.
  • Options trading offers the amount of profit as the stock market. but the cost for options trade is much lower than the stock market which makes options trading much more profitable as you get the same amount of profits but at a lower cost.
  • The option is riskier than stocks, but hedging in options reduces loss and sometimes options are used to avoid risk. The loss in options is limited, and traders know the maximum loss that will occur is the premium paid for buying options.

Disadvantage:-

  1. There is lower liquidity in smoke options which causes difficulty in entering and exiting a position.
  2. There is a higher charge in options trading as compared to stock and future. Sometimes brokers offer a discount which makes the cost lower for trade but generally, the charges to trade are high.
  3. The worst thing is time exhaustion. The price of the option premium falls each day.
  4. Stocks in the share market don’t have option contracts, so it is difficult for traders to hedge against a position and use options strategies.

How to Trade-in options?

Understand Options and basic terms:-

First and foremost, you have to understand what is options trade and terms related to option trade like Holder and writer ( buyer and seller of the option), Premium(Price paid by the holder to write for option), strike prices( Price at which holder can buy or sell), expiry date(termination date of contract), in the money(market price is above strike for a call and below strike for a put), out of money( Market price at which holder can buy or sell), expiry date(termination date of contract), in the money(market price is below strike for a call and above strike for put), at the money(Market price is equal to strike price) and break-even point(Point where there is no profit and loss), etc

Factors that determine the option price:-

There are three factors that affect margin and premium. These factors work on the same basis:-

-Level of the market means if option call strike is more than option put strike then there are chances of gaining more money like in the money

  • Volatility:-  Volatile market increases the option’s premium and if options are in a volatile market then it will pass strike price.
  • Time period:- If the time of expiry is far then it has to pass the strike price and the chance of loss is more and if expiry is near then the chances of reducing profitability is low.

Greek:-

It is a factor that determines option risk. These are named after Greek symbols and measure each factor that affects option price. These factors are Delta(measure sensitivity of price with market movement), Gamma( measure amount of movement when the market moves), Theta(Measure how much market price exhaust over time), Rho( Measure the change in option price due to interest rate change) and Vega(Measure sensitivity to volatility).

Choose a Market Strategy:-

There are different strategies to achieve investment goals like buying a call option(Purchasing call option when market price increase),  buying a put option(Purchasing put option when market price decrease), Hedging or married put(Buying put option to protect it from potential downside loss), a short call option or covered call(short call or sell a call option of current asset), spread or buy and sell the option at the same time, straddle or buying selling calls and puts simultaneously and Buying selling calls and puts at different price aka strangle.

Choose a market for trading:-

There are a lot of markets to choose from in the UK like forex, shares, stock indices and commodities.

Time Period:-

You have to choose how much time you want to invest your money, and you choose according to your investment plans.

Buy or sell:-

Decide if you want to buy or sell/ call or put an option according to your investment goal.

Monitor:-

One you open your position now, you have to look for profit or loss on your option and observe

Which stocks are beneficial in Options Trading?

There are a lot of stocks for option trading, but here are the best stock in 2021:-

  • Rightmove Plc
  • BP Plc
  • Hotel Chocolat group
  • JD Sports Fashion Plc
  • B&M Europe Value Detail
  • Games Workshop Group Plc
  • Next Plc
  • Tesco Plc
  • Aviva Plc
  • Persimmon Plc

Conclusion

Overall there are a lot of choices in options trading, you can buy and sell any underlying stock in the market.  The price of the underlying asset is decided through different factors like expiration date, volatility of the market and level of market price, but buying put and call options will result in a lot of profit. You can invest in this as the loss is limited to the premium. 

There are a lot of trade options strategies that will help you achieve your investment goal. The option gives you the right to buy and sell but there is no obligation to buy and sell option and even though there is no obligation to sell or buy option but you have to make a move before the option expires. 

If you buy a call option then you wait till the price rises up to a certain level before you sell it and if you buy a put option and sell it before the price falls down. There are a lot of stock options like Rightmove Plc and Persimmon Plc which are beneficial in the Uk market. Options contracts allow you to buy and sell shares before the expiry date. There is a low downside risk when the options contract is near expiry. 

There are chances of higher strike prices when you buy call options. Chances of loss are more when a contract is a near expiry in put options. The right option trading strategy can result in achieving the investment goal. The bottom line is that option is good for your profile but it is a little expensive but brokers like ABinvesting provide numerous assets for options trading at low cost.

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