Option Trading Explained
Option trading can be one of the most lucrative investments you can make but they can also be quite risky. Understanding how they work will help you decide if that’s something you want to invest in or would rather avoid.
Essentially, options trading is much like bargain hunting. Let’s say you want to buy a microwave but you want to be sure that you get the top of the line model for no more than $75. You could keep checking the sales and visiting the store but if you could pay that store $3 to notify you when it reaches the price you want to pay, would you? Sure you would!
It would save you a lot of time, searching and trouble to have the opportunity to buy that microwave at the price you were willing to pay. That’s kind of what options trading is like—you are paying a fee for the option of buying a financial product when it reaches a certain price!
Be sure that you know whether you are trading a U.S. or a foreign option. U.S. options are easy to follow and they are regulated, as are all the parties involved in the contract. You should also find out who is guaranteeing the transaction you’re considering. Since foreign financial institutions are not as well monitored as their U.S. counterparts, you need to investigate them carefully.
When assessing your risk be sure to take into account the price appreciation that will be necessary before you can make a profit. If you want to buy an option on oil at $40 a barrel, how long are you going to have to hang onto that oil before you turn a profit? It depends on the market of supply and demand, weather and a lot more. Plan carefully before you decide to take out an option on anything.
It’s not always risky to trade in options. You can reduce your chances of loss by picking index or stock options that have high liquidity with a lot of volume. If you choose one area of trading and become an expert you’ll also reduce your chances of loss. Knowing the options symbols will also help you, as will the bid and ask prices; this knowledge will let you know if you’re getting a fair deal on prices since you’ll know what the last trades have been. Knowing your market well will help your success.
Be sure you know the basic terms of options trading and understand what they mean. A “call”, for instance, gives you to right to buy while a “put” means you are selling. You can make money with a call when the market goes up but a put makes money when the market falls. Remember that time is of the essence in options trading; you have only a certain window of time in which to call or put. You have to be right about where the market is going and know when to take advantage of your option.
Study options in more depth and get to know them intimately before you trade in them. Knowledge is power but in this case, knowledge is money!