Options trading basically involves a contract that allows you to buy or sell stock at a predetermined price by a specific date in the future. The reason one would invest in options are various: you, for instance, need a much smaller initial layout to purchase an option than actual stock; buying an option gives you extra time to gauge what the market is doing; and it acts as a kind of insurance policy that can protect you against a downturn.
There are, however, risks involved. If you are thinking of starting to trade in options, here are a few basic tips to get you going.
Know Your Game
Image via Flickr by marinadelcastell
Although this kind of trading involves quite a lot of scary jargon that you, as a beginner, are probably not familiar with, options trading basics are actually not that difficult to grasp. The first jargon you should familiarize yourself with is “call” and “put.” The former gives you the right to buy, and the latter, the right to sell. A “strike price” is the predetermined price that you will sell or buy for.
So precisely how does this work? If, for instance, you believe that the stock price of a company is going to rise in the future, you buy a call option that gives you the right to buy stock at a certain price and before a specific date. In order for you to make money, the stock price must exceed your strike price before the expiration date. If your predictions were incorrect and the price does not rise before the expiration date, you lose the money that you paid for the options contract.
If you are scared that the price of your shares is going to fall in the near future, you buy a put option, which gives you the right to sell your shares at a specific price before the expiration date, even if the share price has fallen below the strike price. If the share price does not fall as anticipated, you will make no money from selling, and you would once again lose the money you spent on the contract.
Open a Brokerage Account
If you want to trade options, you will need a brokerage account. This can either be an online company such as www.iqoption.com, or you can go for a traditional account with a broker. It is advisable to do your homework when searching for a broker. Ask people who have worked with brokers before for advice, and also, compare commission costs, minimums, and other details before making a decision.
Practice First Through Paper Trading
If you are inexperienced in options trading, it is best to first practice your trading skills through paper trading. This is a way for you to “pretend” that you are trading without actually risking any real money. Enter your trades into practice trading software so that you can monitor your returns over a period of time before actually plunging into the real market.
Options trading is exciting because it gives you the opportunity to make predictions in the market, and if you are correct, either make money or prevent bad losses. It is, however, important to do your homework well and predict accurately, otherwise, you could lose the money that you invested in the contract.