Options trading is one way that investors can take advantage of assets and control some of the risks associated with playing in the market. You can use the options to protect profits, control large amounts of stocks, or reduce losses with a relatively small cash outlay. Options are a flexible investment tool that can help you take advantage of any market conditions. With the ability to generate income, help limit risk, or take advantage of your bullish or bearish forecast, options can help you achieve your investment goals.
Options trading is when you buy or sell an underlying asset at a pre-traded price on a certain future date. Let's say that the option has a delta of 80, which means that the option price will change 80% of the share price change. Because option prices can be mathematically modeled with a model such as the Black-Scholes model, many of the risks associated with options can also be modeled and understood. Again, buying the option will have a cost (the premium), and if the market does not fall during that period, the maximum loss of the option is only the premium spent.
Therefore, a put option is profitable when a share falls below the value of the strike price minus the cost of each option. There are situations where buying options is riskier than owning stocks, but there are also times when options can be used to reduce risk. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading. This particular characteristic of options actually makes them possibly less risky than other asset classes, or at least allows the risks associated with options to be understood and evaluated.
While many brokers have eliminated commissions for trading stocks or exchange-traded funds (ETFs), they still exist for options. You can also combine multiple call and put options to use more sophisticated options strategies that generate profits in a variety of situations. Options trading is how investors can speculate on the future direction of the stock market in general or of individual securities, such as stocks or bonds. Finally, because options trading is inherently short-term, it is likely to generate short-term capital gains.
For example, you'll need to read educational material about the options market and learn how your broker handles accepting options orders. This means that option holders sell their options in the market and writers buy back their positions to close. And, given the complexity of predicting multiple moving parts, brokers need to know a little more about a potential investor before giving them a permission sheet to start trading options. Brokerage firms screen potential options traders to assess their trading experience, understanding of risks, and financial readiness.
A longer maturity is also useful because the option can retain time value, even if the shares are trading below the strike price.