Definition:
Options trading is when you buy or sell an underlying asset at a pre-determined price through a set future date.
To start trading options, you must demonstrate that you know what you're doing before you can begin trading options.
An option trading account requires more capital than opening a brokerage account for stock trading.
Brokers need to know more about their potential clients before giving them permission to start trading options due to the difficulty of anticipating multiple moving parts.
How to open an Option trade
Here are the steps to follow
1. Open a Options Trading account.
because more due diligence is required from the account holder, an account broker company that offers the account will screen potential trader because more due diligence is required from the account holder.
they will assess their financial stamina, trading prowess, Trading risks, and others.
Various documents will be required to be submitted before the deal is signed and account created.
They are:
A: Investment Goals.
B: Trading Experience.
C: Personal financial Information.
D: Type of Options to trade.
The type of options are either Calls or Puts Options trading, covered or naked.
After the assessment the trader will be put on a scale of 1 to 5. 1 Being the lowest value and 5 the highest value.
2. Choose options Call or Put
This are trajectory path on to which the prices of traded asset will take. This are:
a. Call Options
This is where the buyer is given the right to buy a particular asset at the strike price on or before the expiration date in exchange for a premium paid upfront to the seller.
Call options become more valuable as the value of the underlying asset increases.
In online quotes, call options are shortened as "C".
b. Put Options
This is where the seller is given the right to sell a particular asset at the strike price anytime on or before the expiration date in exchange for a premium paid up front.
In online quotes, Puts options are shortened as "P".
3. Predict option strike price
This will be based on the trend of how you think the prices of asset will move in the future.
Example
If you think share prices of company X selling at $60 are underpriced, then buy call option at the strike price. If the share price increase then the outcome will be "in the money"
4. Choose time frame
This is the expiration time offered to choose from on when the option contract will be executed. This will come raging from days, months or years for which when option will run.
Under this style options there are two options: American and European options.
What are the Main features of Options Trading?
1. Strike price
This is the price the option will be executed in. The price is pre-determined.
2. Expiry date
This is the period or time frame set, upon which the options will expire.
3. Premium
This is the down payment amount paid by the buyer for the contract to be opened.
Premium has two components under it:
A. Intrinsic value
B. Time value
What are the States / outcomes of options trading?
1. In the money
This scenario occurs when a broker has accumulated or realized profit from exercising the option trade.
2. Out of the money
In this scenario the broker will have made no money by executing the trade. This happened when the market goes the opposite from what the broker had predicted the price to move.
3. At the money
In this outcome scenario the broker will have neither made gain nor loss when the option was executed.
When the know how and the knowledge of options are apprehended and put to good use it can generate a good chunk of continuous income which will significantly increase your portfolio. Also wrong use of options will have a negative impact on the portfolio.
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