Traders can use options to make bullish and bearish speculative bets on the direction of a stock’s price, as well as hedge their overall portfolio position. Learn more about the two basic types of options traders can trade, called calls and puts, and how these contracts can help you manage risk in your trading.
An option contract gives you the right to buy or sell a financial product at an agreed-upon price for a specified time period, known as the “strike” or “expiration” date. You can find options on a wide range of products, including stocks, commodities, and ETFs.
Options trading For more is a great way to diversify your portfolio, increase your potential for profit, and lower your total investment risk. Options are often less expensive than purchasing the underlying asset, making them a cost-effective way to gain exposure to market movements. They also offer a higher reward-to-risk ratio than other investments, such as purchasing or shorting shares of a stock.
There are many types of options, and you can choose the ones that best suit your trading strategy and risk tolerance. To make a trade, you must select the type of option, such as call or put, the strike price, and the date by which you expect the stock to move (the expiration date). You will also be given information about the option’s bid price, current value if sold, daily change in price, and breakeven point.
The biggest advantage of buying options is that you can limit your losses to the price of the option’s premium, which is paid for at the time of purchase. Let’s say you think that Retail Stock will climb to $12 a share within one month, and you can buy the stock’s $10 strike option for a premium of $2. If the stock rises to $12 or above, you will realize a profit. But if the stock falls to below $19, you will break even and have limited your risk to just the premium of $2.
On the other hand, selling options can expose you to unlimited risk. You must deliver the underlying asset to the buyer if you sell an option that is in-the-money, or at-risk, at expiration. If you sell an at-risk option, you may be forced to buy the underlying asset and pay a large margin bill if the price is above the strike price of your option when it expires.
It is important to develop a trading plan and stick to it. This will help you establish more successful patterns, reduce your incidence of losses, and sleep better at night. Determine an upside exit point and a worst-case scenario you are willing to tolerate on the downside, and set the timeframes for each of these well in advance. This can keep your emotions in check and prevent you from taking on too much risk when things are going your way. Likewise, it is essential to clear your position and take profits when they are reached.