Introduction:
As a beginner investor, chances are that you might not be fully aware of the instruments available to you. In addition to stocks, forex, ETFs, mutual funds, and precious metals, there are also options which you may want to give a try.
The Chicago Board Options Exchange (CBOE).
Here is an introductory guide on how to trade them.
Options: What are They?
So, what are options? And how do they work? Well, options are contracts that give their buyers the right but not the obligation to buy a specific asset (e.g. stock, bonds, commodities, market indices, etc.) at a specific price on or before a specific date.
Because they “derive” their value from those specific assets, all options are grouped into a unique investment class known as “derivatives.” As a result, the price of a derivative is determined by the fluctuations in the price of the particular asset that underlies it.
Options have two types: call and put. A call option gives its holder the right to buy its underlying asset at a specific price within a specific timeframe. A put option, on the other hand, requires the holder to sell its underlying asset also within a specific time.
How to Start Trading Options
Options can be traded via any of the majority of online retail brokers through which other assets are also traded. To start, you will need to first open an options trading account.
Next, through adequate research, you have to decide the direction you think a particular stock is headed and the time frame during which it is likely to move. That will determine the type of option you will buy.
Benefits of Trading Options
Options are a versatile instrument. And there are many reasons why you might want to get started in trading them. However, the three most important of those reasons are:
- Hedging
Interestingly, options were actually invented to reduce risks. And that they continue to do quite well. Imagine you want to buy a stock but you want to reduce your downside risks. In that situation, you can buy a put option on it. Otherwise, if you will be going short, you can buy a call option to help limit your losses if the stock goes up instead.
- Income
Beyond hedging, you can also choose to trade options to earn directly. You can do that as conservatively as possible if you already own some stocks. To generate a regular source of income with options using your own stocks, you do not have to buy puts or calls. Instead, you just have to sell them against the stocks you already own or want to own.
This strategy of selling puts or calls against stocks is based on the fact that close to 80% of all written options expire out of the money.
- Speculation
Options are an excellent speculative product. Since they provide leverage and are highly cost-effective, many investors find them attractive for wagering on the future prices of assets. For instance, if you think the price of a $100 stock will increase, you can use a call option contract to speculate on it.
By buying a call option, you will be using just a few dollars instead of coughing up a lot on buying the stock itself.