Options Trading are an excellent investment choice for investors looking to diversify their portfolios beyond stocks, bonds, or mutual funds. While options are a high-risk investment, they can also yield high returns.
However, options are complex investments, making them unsuitable for inexperienced investors. They are generally better suited for investors with experience investing in other securities. But what exactly are options? This post explores what options are and the fundamentals of options trading.
Options trading is simply trading options. Options are contracts that give the option holder the right – but not the obligation – to trade security like stock. And, options contracts usually last for a specific period. They can be as short as a day or even last several years. Options holders can trade in a security at a set price within the contract period.
Options can be divided into two categories – calls and puts.
They give the option holder the right to purchase an underlying security at a specified price within a certain period. The price paid is called the strike price.
Conversely, put options give the options holder the right to sell an underlying security at a specified price within a certain period. Similar to call options, the selling price of the security is also known as its strike price.
Before investing in options, consider the following seven factors.
Current Stock Price
Naturally, investors consider the stock price before investing in options. When the stock price rises, calls appreciate because the underlying security can be purchased at a lower price and puts decline. Conversely, puts appreciate and calls decline as the stock price drops.’
The strike price is the security’s predetermined price if it is bought or sold as stated in the option contract.
Picture a scenario with two option contracts. One call option has a $50 strike price, while the other has a $100 one. The stock is valued at $85, and all other factors of both call options are constant except the strike price.
Upon expiry, the first contract is worth $35 because it’s trading $35 higher than the strike price. Meanwhile, the second contract won’t generate any profit for the option holder because it’s trading $15 lower than the strike price.
Options contracts usually have an expiration date. Generally, the more time available until expiry, the higher the chances of making a profit. Conversely, the closer the expiry date, the lower the value of an option.
Investors usually consider the market conditions and their personal goals before investing in either option type. Calls are ideal for investors who want to take advantage of falling prices, while puts are better suited for investors who want to take advantage of falling prices.
As with other securities, options are affected by interest rates. Call options rise as interest rates rise, while puts decline. The reverse happens when interest rates drop.
Volatility is arguably the most significant factor that influences options trading. It involves examining the history of a stock over a certain period. Understanding volatility helps investors to establish when it is a good time to buy or sell options.
Finally, options trading starts with establishing clear financial goals. Having clear financial goals enables investors to develop proper strategies when investing in options.
Options trading can be relatively complex. But it isn’t impossible to learn. By partnering with SoFi Invest, investors with experience trading in other securities have learned how to trade options and diversified their portfolios.