An option is a contract that states you have the right to buy or sell an asset at a certain price at any time before a certain date, but you are under no obligation to do so. Options are divided into buy and put options or "call" and "put" options. With a call option, you have the right to buy an asset at a specified price before a specified date. You would buy this option if you expect the asset value to increase before that date, so you can buy it at a lower price. Sell option otherwise. You buy the right to sell the asset, which is useful if you think the price of the asset will drop before a certain date. That is the basic process of options trading, although in practice it is very complex and very risky. If you are interested in this high-risk investment, make sure you take the time to study it and invest only with risk capital.
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Part 1 of 4: Understanding Options
Step 1. Know what options mean
An option is a contract that gives the holder the right to buy or sell the underlying security at a set strike price within a certain period of time (term). The strike price may be lower or higher than the current price of the underlying security (market price). Just like stocks or bonds, options are securities. Options are traded on exchanges or traded at foreign brokers. Although a person can increase his or her cash (options control a larger share value), options are high risk because they will eventually expire.
Step 2. Understand the risks of options trading
Options can be purchased speculatively or as a hedge against losses. Speculative buying allows traders to make large sums of money, but only if they can accurately predict the magnitude, timing, and direction of price movements of the underlying security. It also allows traders to experience heavy losses and high trading commissions. This is what makes options trading risky, especially for novice traders.
However, options can also be used as a strategy to protect your investment. For example, you can buy a put option to sell your stock if you are worried that the price will drop suddenly. This method of using the option is rather safe because you will only lose at the contract price
Step 3. Read and understand the booklet entitled "Characteristics and Risks of Standardized Options"
This booklet was written in accordance with SEC regulations. Brokerage firms share this booklet with those who open options trading accounts. In the book, you will find out more about options terminology, the different types of options that can be traded, exercise and settlement options, tax calculations for options traders, and the risks associated with options trading.
Step 4. Understand the basic types of trading
There are two main types of options trading: put options and put options. Both represent the right to buy or sell a security at a certain price within a certain period of time. Specifically, the two types are:
- A call or call option is an option or right, but not an obligation, to "buy" an asset at a specified price within a specified period of time. The purchaser of a call option expects the price of the underlying stock to rise over the term of the option. For example, a buyer purchases a call option on a stock at an strike price of $100. The buyer predicts that the stock will go up (say $105 per share), but he will be able to buy the stock for $100. If he wanted, he could turn around and sell the stock for $105 and make a profit. Otherwise, the buyer will lose the cost of the bid.
- A put option or "put" is an option or right, but not an obligation, to sell an asset at a specified price within a specified period of time. The buyer of a put option expects the price of the underlying stock to fall over the term of the option. In this case, the buyer can force the seller (writer) of the put option contract to buy the asset at a price before the settlement.
- You can open a position by buying or selling a buy or sell option, closing it by taking the opposite action, exercising it, or allowing it to expire.
Step 5. Learn by doing
Take a look at the glossary of options trading terms, arrange the terms in a table, print them out and start learning. Here are some very basic terms:
- The "holder" or buyer is the person who has purchased the option.
- The "writer" is the person who has sold the option.
- The "strike price" is the price the asset will be bought or sold (depending on whether it's a buy or sell option). This is where the stock price will go up (for a call option) or down (for a put option) before the option can make a profit.
- The "expiration date" is the agreed date on which the option holder must exercise his right to buy or sell the underlying security. Once this date is reached, the option expires and the holder loses his rights.
- "In the money" is a phrase used to indicate that the market price of an asset is higher than the strike price (if in a buy position) or lower than the strike price (if in a short position).
- "Out of the money" is a phrase used to indicate that the market price of an asset is lower than the strike price (if in a buy position) or higher than the strike price (if in a short position).
Part 2 of 4: Preparing for Options Trading
Step 1. Open a brokerage account
If you wish to trade options, you will need to open a brokerage account to enter your transactions – this can be done online at sites such as www.iqoptionsbid.com or even a traditional account with a broker. Make sure you understand what it takes to open a brokerage account before doing so.
- Compare options trading commissions from different brokers. Some companies don't even offer commissions for options trading.
- Do some online research and read reviews of the brokerage firms on your short list. Learn from other people's mistakes so you don't have to repeat them.
- Be wary of scam trading sites and platforms. Always research the platform thoroughly before depositing any money. Avoid platforms that have received negative reviews or have been reported for fraudulent activity.
- Cash accounts will only allow the purchase of options to open positions. If you want to sell the option to open an account without owning the underlying assets, you need a margin account.
- If you decide to trade online, make sure your online broker accepts secure forms of payment such as secure credit card payment gateways, or third party payment systems such as Skrill, PayPal, Payoneer, Bitcoin, etc.
Step 2. Get approval to trade options
You must get approval from the broker before you can start buying and selling options. The brokerage firm that handles the account will set limits based on experience and money in the account, and each company has its own requirements aimed at making sure customers know what they're doing. You cannot sell closed call options without an options account. Brokerage firms want to make sure customers understand the risks before making a trade.
The sale of a closed call option involves selling the right to buy your shares at the strike price during the term of the option. The buyer has the rights, not the seller. Shares must be in the broker's account and cannot be sold or transferred while the call option is still in effect
Step 3. Understand technical analysis
Options are usually short-term investments, so you should pay attention to the price movements of the securities being optioned for some time later to get a fresh return on funds. In order to accurately predict price movements, you must understand the basics of technical analysis.
- Learn about support and resistance levels. This is the point when the stock rarely falls below (support) or rises above (resistance). Support is the price level at which historically significant purchases of securities have occurred. Resistance is the price level at which a significant sale of a security has occurred in the past.
- Understand the importance of volume. If a stock is moving in a certain direction with a lot of volume behind it, it usually signals a strong trend and could be an opportunity to make money.
- Understand graphic patterns. History tends to repeat itself, even when it comes to stock prices. There are special patterns that you should pay attention to in stock price movements that can indicate the direction of price movements.
- Learn about moving averages. It often happens that the stock price crosses above or below a certain moving average of the previous price. The 30-day moving average is considered more reliable than the 10-day moving average.
Part 3 of 4: Starting Options Trading
Step 1. Start with simulated trading or paper trading
Avoid the temptation to bet your hard-earned money on a technique you just learned. Instead, choose practice or simulated trading. Make "fake" trades using tables or practice using trading software. Then, evaluate your profits for at least a few months. If you make a decent profit, slowly enter into real trading.
- Simulated trading is not the same as real trading as there is no psychological pressure or commissions imposed. This is a great way to learn the mechanics of trading but is not a true determinant of results.
- Real options trading is very risky and can lead to huge losses for the trader. Trade only with money you can afford to spare.
Step 2. Use limit orders or limit orders
Avoid paying the market price for options as the exercise price may be higher than expected. Instead, set your price with limit orders and maximize your profit.
Step 3. Re-evaluate your strategy periodically
Determine if there is anything you can do to increase your profits. Learn from mistakes while repeating successful strategies. And stay focused on your strategy; traders focus on multiple positions, rather than diversifying. You must have no more than 10 percent of your investment portfolio in options.
Part 4 of 4: Switching to Advanced Options Trading
Step 1. Join an online forum of like-minded options traders
If you're into advanced options trading techniques, you'll find online trader forums a valuable source of information (and support, after heartbreaking losses). Look for these forums so you can learn from the successes and failures of others.
Step 2. Consider other options trading strategies
After completing several successful trades, you can get approval for more complex options trading strategies. However, start with simulated trading as well. This step will allow you to run it in real trading more easily.
- One such strategy is the "straddle", which involves trading on both sides of the market, buying put and buying options at the same strike price and expiration date, so you can limit your exposure. This strategy is most effective when the market is moving up and down, rather than moving in one direction. This move also carries the risk that only one side of the trade can be executed.
- The same strategy is the "strip", which is similar to the straddle, but is a "bearish" strategy by multiplying the earning power on a downward price movement. Similar to a straddle in execution, but with twice as many bought options on the downside (sell options).
Step 3. Learn about Greek
Once you have mastered simple options trading and have decided to move on to more complex options trading, you need to learn what "Greek" is all about. It is a measure used by options traders to maximize their profits.
- Delta-the amount of the price movement of the option relative to the price movement of the underlying asset. An option with a delta of 0.5 will have a price move of half of the underlying asset. If the stock moves $1.00, the option price will move $0.50.
- Gamma -the rate of change of the delta based on the $1 change in the stock price.
- Theta -the so-called "decay time" of the option price. It measures how much the price deteriorates as the option gets closer to expiration.
- Vega - the amount of the option price changes based on the volatility of the underlying asset.
Tips
- Practice simulated trading before risking your money.
- If you trade on margin, be prepared to experience a margin call.
- It is very useful to have a margin account if you want to sell an uncovered call option or sell a put option. Otherwise, you can only buy options and sell closed call options. However, depending on the amount of cash and equity in your account, you may not be given approval to trade on margin.
- Never trade with money you can't afford to give up.
- Never put more than 10% of your savings into options trading.
Warning
- Like any other trade, options carry risks. You risk losing all the money you put into trading options.
- Be wary of binary options trading, unless you are a very experienced trader. For inexperienced traders, binary options are considered a mere gamble.
