Mastering the Art of Options Trading

Trading options involves engaging in the practice of trading assets based on a stock's trading price. As an options trader, you are essentially making predictions on whether a stock's price is set to increase or decrease during a specific timeframe.

If you have been exploring various investment avenues, you are probably already familiar with stocks, mutual funds, real estate, bonds and more. However, if you are looking to diversify your investment portfolio and maximise profits, it may be a good idea to add options trading to your list.

But what are options, exactly? Essentially, options are financial assets that act as derivatives of stocks. An options contract gives the owner the right to buy or sell a specific stock at a predetermined price, within a certain period. This means that options allow you to buy or sell shares at a specific time, without actually owning the stock itself.

It's important to note that an options contract does not mean you own a stake in the company and you are therefore not entitled to any associated benefits like dividend payouts. Essentially, options trading is like making a prediction on the direction in which you think a stock's price will move.

An option's value is directly tied to the price of the underlying stock. One common use of options that you may be familiar with is the provision of stock options to employees by businesses. Depending on how well the company is doing, this could be a great perk for employees.

To begin trading options, you will need to work through a brokerage.

The reason options trading is often seen as a risky investment lies in the fact that much of the process is based on speculation. Your options trade will ultimately hinge on whether you think a stock will rise or fall in value. This will determine whether you choose a call or a put option. Choosing a call option means you believe the stock price will rise, and so you are willing to buy the stock at a higher price on a future date. A put option, on the other hand, is when you believe the stock price will decline, and therefore are willing to sell shares at a specific price during a certain period.

It's important to note that for both call and put options, the option's price must be above or below a certain predetermined price. For a call option, the stock price must rise above your pre-agreed 'strike price' before the expiry of your option contract. If you have a put option, you want the stock price to fall below your strike price within the time period of your contract.

Consider this example: let's say you have identified a stock trading on the S&P 500 at $100 per share. You believe that the price of that stock will rise to $150 at some future date. You could purchase a call option at a strike price of $120 per share, valid for six months. This means that if the stock price does rise to $150 within that timeframe, you can purchase the shares at $120 per share. This means that you've purchased the shares at a lower price than the market value and can then sell them at a profit.

However, this kind of options trading can also be risky. If the stock price doesn't rise above your strike price, you will lose money. For this reason, options trading is recommended only for experienced traders who have the time and resources to stay abreast of market developments.

So if options trading is so risky, why do some investors buy options? For experienced traders, options trading can be a great way to maximise profits. Options can also be a good way to test out new businesses, such as Company X. If you believe that Company X is likely to experience rapid growth, you could buy a call option that is valid for six months. If the stock price rises above your strike price during that time, you are in the market with a profitable stock at below the market price. But if the stock prices don't rise as you had predicted, your losses will be limited to the amount you paid for the option contract.