Option Trading Definition: Starting Point

Option Trading Definition: Starting Point

Option trading is a risky but often very profitable business. Naturally, before getting into it, one should try to understand its essence, and here's the right place where you can get an option trading definition.
Option Trading is simply the trade in option contracts over an exchange.

Alongside with such investments as stocks, bonds and mutual funds, options are complex securities giving its holder the right to buy or sell the asset (usually, stocks or indices) underlying tthem at an agreed price in a specified period of time. In other words, options are contracts with set terms and properties. It is important to bear in mind that the contract provides the option to buy 100 shares; so its price should be multiplied by 100.

As has been mentioned above, two types of options can be singled out in option trading depending on what right they give their holder – to sell the asset or buy it – called accordingly puts and calls. Thus, there are four main participants at the market of option trading. They are: buyers of calls, sellers of calls, buyers of puts and sellers of puts.

Option buyers obtain the right to buy the stock at a certain price even if by the end of the prescribed term it actually significantly adds in price. However, if it doesn't, it's not an obligation to let the expiry date pass by, losing at that money paid for the possibility to exercise the option. Buyers are considered to have long positions in option trading. The other party involved in option trading, that is, calls and puts' sellers, also known as writers, are obliged to buy or sell, having short positions. There are 2 styles of options: American Options, that can be exercised at any time before the expiration date and European Options exercisable only at the date of expiry.

The price of the underlying asset at the time of contract conclusion is the strike price. If the former is higher than the latter before the expiry date, the option is 'in-the-money'. Correspondingly, a put option is said to be in-the-money when the stock price goes below the strike price. Spread between these two positions in option trading is called intrinsic value.

Option's total price made up of such factors as the share price, strike price, time value and volatility, is referred to as the premium.

Options are used for two main purposes: for speculation (making profit) and hedging (insuring your investments). Sometimes they are also used in employer-employee relationship.