Options trading is a great way to amplify ROI on smaller accounts and/or hedge another position in your portfolio. But executed poorly, trading options can also result in amplified losses and a blown account in a short span of time. To help you consistently profit from the options market, an investor must fully understand the underlying fundamentals that many inexperienced and unsuccessful traders irresponsibly neglect.
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What is an Option?
Before opening a broker account and making your first trade, it’s only logical to develop a firm grasp of what options are. In the financial world, options are contracts that represent underlying security, i.e. stock. You can buy or sell these contracts to gain greater leverage and amplify small positions or price moves. You can also use an options contract to hedge your bet on another security.
According to the experts at SoFi, “Options holders can buy or sell by a certain date at a set price, while sellers have to deliver the underlying asset. Investors can use options if they think an asset’s price will go up or down or to offset risk elsewhere in their portfolio.”
Different Types of Option
There are two main types of options you can buy or sell – call and put. A call option pertains to a contract that allows the holder to buy shares of a company’s stock at the predetermined price called Strike Price. Note that executing the contract is purely optional. The contract holder is not obliged to purchase any stock at or before the contract’s expiration.
The other type of options contract is a put option. The investor essentially purchases the right to sell a predetermined number of shares of company stock at a fixed price at some point in the future. Similarly with a call option, executing a put contract is simply optional and not obligatory.
In, At, and Out Of the Money
These are the terms used to describe the profitability of your options contract. When talking about stock movement, you can normally just describe price and positions as going up, down, or flat. When talking about options, however, traders usually describe it using one of these three terms. What these terms imply will slightly vary based on whether or not it is a put or call option.
A call option that’s in the money means that the strike price is below the underlying stock’s current market price. Put options, on the other hand, mean that the contract’s strike price is more than the current market price.
An out-of-the-money contract, on the other hand, means that the option is not profitable when exercised. It often indicates that the current market price is significantly higher or lower than the strike price.
Lastly, the money options mean that the current market price and the strike price of the contract are the same. If the holder of the contract sells the option, they can profit or lose money. If they decide to exercise the option, however, the trade is considered in the red due to the premium paid to buy the contract.
Options trading is a high-risk business that requires careful planning and preparation beforehand. Invest time and effort in learning the different terms and strategies available. You’ll also want to read up on the different broker services and dashboard features available before you start to trade options with SoFi.