What is Option Trading?

What is Option Trading?

An option is a contract that allows an investor to buy or sell an underlying instrument such as a security, ETF or index at a fixed price over a certain period of time.

What are the options?

An option is a contract that allows (but does not require) an investor to buy or sell an underlying instrument. Such as a security, ETF or even index at a predetermined price over a certain period of time. The option market consists of buying and selling, which contracts on the basis of securities. Buying an option that allow you to buy a share at a later time is called “call option”. While buying an option that allows you to sell shares at a later time is called a “put option”.

However, options are not the same as stocks because they do not represent ownership in a company. And, although futures contracts are used as options. Options are considered less risky due to the fact that you can withdraw (or move away from) an option contract at any point. The option price (its premium) is thus a percentage of the underlying asset or security.

When buying or selling an option, the investor or trader has the right to exercise that option at any point until the expiration date. So simply buying or selling an option does not mean that you actually have to buy / sell it Have to exercise at the point of. Because of this system the options are considered derivative security. Meaning that their value is derived from something else (in this case, from the value of the asset, like markets, securities, or other underlying instruments).

Why would an investor use options?

Buying options are basically placing bets in stocks to hedge a trading position up, down or in the market.
The price at which you agree to purchase the underlying security through the option is called the “strike price”. And the fee you pay to purchase that option contract is called the “premium”. When determining the strike price, you are betting that the asset (usually the stock) will move up or down in price. The price you are paying for that condition is the premium, which is a percentage of the value of that property.

There are two different types of options – call and put options. That give the investor the right (but not the obligation) to sell or buy securities.

Call Option

A call option is a contract that gives the investor the right to buy certain security or a certain amount of commodity shares at a certain time over a certain amount. For example, a call option would allow a trader to buy a certain amount of shares of stocks, bonds or other instruments such as ETFs. Or indexes at a future time (by the expiration of the contract).

If you’re buying a call option, it means that you want the stock (or other security) to go up in price. So that you can make a profit from your contract using your right to buy those shares. (And usually immediately Sell ​​them to capitalize on the profit).

The fee you are paying for purchasing the call option is called the premium. (It is essentially the cost of buying the contract that will eventually allow you to buy the stock or security).

Put Option

In contrast, a put option is a contract that gives the investor the right to sell a certain security. Or commodity shares at a certain time in excess of a certain amount. Like call options, a put option allows the trader the right (but not the obligation). To sell the security by the expiration date of the contract.

Long vs. short options

Unlike other securities such as futures contracts, option trading is generally a “long” one. Meaning that you are buying the option with the expectation of a price (in which case you will buy the call option). However, even if you buy the put option (the right to sell the security), you are still buying a longer option.

Shortening an option is selling that option. But the profit of the sale is limited to the premium of the option – and. The risk is unlimited. For both call and put options, the more time left on the contract, the higher the premium.

Historical vs implied Volatility

Volatility in option trading refers to how large the price swing is for a given stock. As you would imagine, high volatility with securities (such as stocks). Means high risk – and furthermore, low volatility means low risk.

When trading options on the stock market, high-volatility stocks (whose stock prices fluctuate greatly) are more expensive than those with low volatility. (Although due to the erratic nature of the stock market, even That low-volatility stocks can be high-volatility) finally).

Historical fluctuations are a good measure of volatility as it measures how much the stock fluctuates from day to day over a one-year period. On the other hand, implied volatility is an estimate of future stock (or security). Volatility based on the market at the time of the option contract.

Time value: at / in / out of money

If you are buying an option that is already “in money” (meaning the option will be immediately in profit). Then its premium will have an additional cost because you can sell it immediately for profit. And, as you can guess, an option that is “out of money”. It Will not be an added value because it is not currently in profit.

For call options, “in money” contracts will be those whose underlying asset price (stock, ETF, etc.) is above the strike price. For a put option, the contract will be “in money”. If the strike price is less than the current price of the underlying asset (stock, ETF, etc.).

The time value, also known as the extrinsic value, is the value of the option above the intrinsic value (or, above the “in money” field).

If an option (whether a put or call option) is going to be “out of money” by its expiration date. You can sell the option to collect a time premium.

The longer an option before its expiration date actually has more time to make a profit. So its premium (price) is going to be higher because its time value is higher. Conversely, the shorter the time before an option contract expires. The lowers its time value (less additional time value will be added to the premium).

So, in other words, if there is a lot of time before an option expires. Then the extra time value will be added to the premium (value). And if there is less time before the expiration, a lower time value will be added to the premium.

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