You might be scared of options trading because you don’t want to do it the wrong way! If this is the case, read our article to learn how to trade options the right way. In this article we will cover 3 different goals you might have and then explain 5 different ways you can trade options. Read this article to decide which way to trade options is the right way for you. This is a great “how to trade options 101” article that will get you off to a great start!
What is the "Right Way?"
I know you want progress from the beginner level and learn how to trade options the right way but what do we mean by “right way.” Well, the right way for you might not be the right way for me. Trading options the right way really depends on your goals so let’s cover 3 goals you might have in regards to option trading.
Obtaining put options is a good way to protect your stock investments against falling stock prices. A put option guarantees that you can sell your stock at a predetermined price, also known as a “strike price.”
For example, If you were to buy 1000 shares of stock at $5 dollars, you could obtain some put options to cover these shares in case the stock price goes down. If the stock price goes up, you can sell your shares for a profit. If the stock price goes down, you can exercise your options and minimize your financial damage.
Options allow for people to invest in stock with only a small percentage of the capital actually required to buy the stock. You can buy call options that will guarantee that you can buy the stock at the strike price in the future. A great benefit of this, is that you can only ever lose the premium you pay for the options. You won’t have to worry about losing your stock investment because you haven’t made one.
Options only cost a small fraction of what it would cost to buy the stock outright. This means that you can leverage your capital and stand to profit from the stock prices of many more companies than you would be able to by just buying and selling stock.
The right ways to buy options
Hold Until the Expiration Date
This is a good way to trade if the stock price is steadily increasing. You would hold onto the option and exercise it just before the expiration date. For example, if you had call options for stock ABC that was steadily growing above the strike price of the options, you may want to hold onto these options and then exercise them just before the expiration date. You could then sell the stock for a profit right away.
Exercise Before the Expiration Date
You may want to exercise your options before the expiration date. You would do this when stock prices are volatile. You may determine that a stock price will not go any higher or you think it is likely to decrease in value. It’s a good idea to exercise your call options to buy the stock at the strike price. You can then sell your new stock at the market price for a profit.
Do Not Exercise the Option
You are free not to exercise your options. The stock price may be below the strike price of your call option. In this case, you will not want to exercise your call options. Of course, you will lose the cost of the premium you paid, however, this is a small loss compared to the capital you would have lost if you had actually invested in the stock.
The Right Ways to Sell Options
Issuing Covered Call Options
You may decide to issue a call option when you buy stock. This is known as a “covered call option.” You are issuing an option that requires you sell your stock at the agreed upon strike price in the option contract. An advantage of this is that the buyer of your options will pay a premium that you will obtain.
This is a good way to minimize your risk. Keep in mind that if the stock price rises, the option holder will more than likely exercise these options. Basically, you will not benefit from increases in stock market increases of your shares as you will have to sell your stock at the strike price.
Issuing Uncovered Call Options
This is a very risky way to trade options. If you are just beginning to learn how to trade in options, you may want to stay away from this method until you have more experience trading options. Issuing uncovered call options means that you issue a call option for stock that you do not actually own.
If the stock price decreases then you have made some money off the premium you charged to the recipient of these options, however, if the stock price rises then the option holder will more than likely exercise these options.
This means you will need to buy the stock at the higher market price and then sell it to the option holder at the lower strike price. You stand to lose a significant amount of money if you issue uncovered calls.
Now you know the right way to trade options! We have covered a few different goals that should have you thinking about what is most important to you when it comes to options trading. You might be looking for a risky high reward or you might just be looking to protect your investment. Whatever your goals are, you now have a 5 great ways to trade options and you may want to learn about options strategies. Congratulations on learning how to trade option the right way!
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