Basic explanation of option trading
For each underlying asset , there are many different options available. Above is a small sample of the options for Apple stock for just one expiration date, December 16, The Strike column in the center of the chain lists the strike prices that are available.
The columns to the left of the Strike column refer to call options, while those on the right refer to puts. In this list that right is good through December Once you have paid for a call option you can buy one for the price shown in the Ask column, times , you then have the right buy the stock at that price no matter what the market price of Apple stock is at some future date between now and expiration.
This will allow you to make money if Apple stock goes up while risking only a small fraction of the stock price. If you own the stock, this is like a guaranteed stop-loss. Besides the options listed above that expire in December, there are other expiration dates available as shown below:. The expiration dates above range from November 11, , which was just 2 days away when this article was written; to January 18, , more than two years away.
For every one of those expiration dates there is a list of available option strike prices that is similar to the one in the first diagram above, altogether there are over options for Apple stock. Once you understand the world of options, all these possibilities are open. Stay tuned for future articles. If this piques your interest, check with your local center on option classes offered in your area. Disclaimer This newsletter is written for educational purposes only. One of the big advantages of options contracts is that you can buy them in situations when you expect the underlying asset to go up in value and also in situations when you expect the underlying asset to go down.
If you were expecting an underlying asset to go up in value, then you would buy call options, which gives you the right to buy the underlying asset at a fixed price. If you were expecting an underlying asset to go down in value, then you would buy put options, which gives you the right to sell the underlying asset at a fixed price.
This is just one example of the flexibility on these contracts; there are several more. If you have previously opened a short position on options contracts by writing them, then you can also buy those contracts back to close that position. To close a position by buying contracts you would place a buy to close order with your broker.
There are basically two ways in which you can sell options contracts. First, if you have previously bought contracts and wish to realize your profits, or cut your losses, then you would sell them by placing a sell to close order.
The order is named as such because you are closing your position by selling options contracts. You would usually use that order if the options you owned had gone up in value and you wanted to take your profits at that point, or if the options you owned had fallen in value and you wanted to exit your position before incurring any other losses. The other way you can sell options is by opening a short position and short selling them. This is also known as writing options, because the process actually involves you writing new contracts to be sold in the market.
When you do this you are taking on the obligation in the contract i. Writing options is done by using the sell to open order, and you would receive a payment at the time of placing such an order. This is generally riskier than trading through buying and then selling, but there are profits to be made if you know what you are doing. You would usually place such an order if you believed the relevant underlying security would not move in such a way that the holder would be able to exercise their option for a profit.
For example, if you believed that a particular stock was going to either remain static or fall in value, then you could choose to write and sell call options based on that stock.
You would be liable to potential losses if the stock did go up in value, but if it failed to do so by the time the options expired you would keep the payment you received for writing them. Options traders tend to make their profits through the buying, selling, and writing of options rather than ever actually exercising them.
However, depending on the strategies you are using and the reasons you have bought certain contracts, there may be occasions when you choose to exercise your options to buy or sell the underlying security. The simple fact that you can potentially make money out of exercising as well as buying and selling them further serves to illustrate just how much flexibility and versatility this form of trading offers. What really makes trading options such an interesting way to invest is the ability to create options spreads.
You can certainly make money trading by buying options and then selling them if you make a profit, but it's the spreads that are the seriously powerful tools in trading. A spread is quite simply when you enter a position on two or more options contracts based on the same underlying security; for example, buying options on a specific stock and also writing contracts on the same stock.
There are many different types of spreads that you can create, and they can be used for many different reasons. Most commonly, they are used to either limit the risk involved with taking a position or reducing the financial outlay required with taking a position.
Most options trading strategies involve the use of spreads. Some strategies can be very complicated, but there are also a number of fairly basic strategies that are easy to understand. You can read more about all the different types of spreads here. There are actually a number of benefits this form of trading offers, plus the versatility that we have referred to above.
It's continuing to grow in popularity, not just with professional traders but also with more casual traders as well. To find out just what it is that makes it so appealing, please read the next page in this section — Why Trade Options?
What is Options Trading? Section Contents Quick Links. What Does Options Trading Involve?