Basic Option Trading Concepts to Learn
Option trading is a risky and thus often very profitable and challenging business. Among the wide variety of securities that your portfolio can include there might be some place for options. But even if you are not going to take the risk participating in option trading it is useful to learn some basic option trading concepts at least to be able to decipher the talks on option trading matters that otherwise may sound misleading.
One of the good reasons to go into option trading is that it provides great opportunities to the option trading market participants. Here you can adjust to market behavior and profit being both speculative staking on stock or index advance, and conservative protecting your positions from decline.
There are basically two types of options. They are called puts and calls.
The former is an option contract that gives its owner the right (and not the obligation!) to sell a specific amount of the underlying security (usually, stocks) at an established price before the expiration of an agreed period of time. A put gets more valuable if the price of the underlying asset falls compared with the strike price.
The opposite to it is a call option, which gives its holder the right to buy stocks at pretty much the same conditions. A call brings profit if the underlying grows in price.
Options are also called derivatives as their price derives from the assets (stocks or other securities) underlying them as well as other factors including time value and volatility. The total price of an option (stock price + strike price + time agent) is called the premium.
The four participants of options trading markets are: buyers of calls, buyers of puts, also called holders; sellers of puts and sellers of calls. The latter are also referred to as writers. Being a writer is extremely risky, especially in a naked position, that is, not hedging from potential risks. However, profits appear considerably higher, too.
Options sold on registered exchanges (listed options) usually come in two types. These are American- and European-style options. American options can be exercised at any time before the expiration date, and European ones - at the end of their lives only. Options of the former type prevail on the national market of option trading.
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