Options trading allow traders to control a stock for a fraction of its per-share price without ever owning it. The leverage and volatility of options trading can create dramatic results with small amounts of capital. Learning the ins and outs of options trading strategies and how to trade options gives you a powerful tool for making profits no matter what is happening in the overall market.
Options trading is when an investor trades contracts, rather than shares of a company as with stock trading. These contracts let the buyer buy or sell stock at a later time. Options trading covers contracts like securities, ETF or even a stock index, all of which we'll explain below.
Options trading is different than trading stock; but developing a reliable strategy for options through education and the right guidance can allow beginner or intermediate traders to take advantage of this part of the market and expand their portfolio to hedge against risks. Though trading options can seem overwhelming to beginners due to some of the complexities involved in analyzing the market and making informed trading decisions, options are a versatile trading instrument and an important part of a trader's capital-preservation toolkit. So, don't stay away from options just because they're difficult to understand at first. Instead, get the right education and learn about the various options trading strategies that are available.
Options can be combined in multiple ways creating all sort of options strategies which can be very conservative, less moderate or something in between. Traders who believe the market is headed up can buy calls which allow them to buy a stock at a specific price, no matter how high the price may actually climb. Puts are for people who think the market is headed down; if they are correct, no matter how low a stock goes, they can sell it at the strike price according to the contract.
Options can also be used to offset potential losses. For example, traders who own a stock and think its value might go down, can offset some of its risk by selling a call option at today's price. What they earn by writing the option partially offsets any potential loss on the trade if they are wrong. Additionally, if a trader wants to buy a stock but feel it is overvalued at today's price, they can effectively lower the price by selling a put which commits them to buy if it reaches their desired price. They make money from the put, whether or not they end up owning the stock.
Because the value of options is tied to price movement over a given period of time, options are far more volatile than stocks and price changes are dramatic; a $100 stock that goes to $110 has seen a 10% increase, but this might translate to a 100% increase in an option that allows you to buy at $100 anytime in the next six months. It's not unreasonable that traders ask themselves, "Why should I spend $100 to buy a stock when I can control it with a $5 or $10 option?"