A move from ‘Options Dummy’ to trading options requires some fundamental knowledge. If you want enough basics to begin trading put options and call options, this options trading for dummies Course is a good start.
But understand, option trading is serious business. It is speculative and has the associated risk of loss.
Let’s get started by looking at trading options for dummies!...
Options 101 : Trading Options for Beginners
You’ll notice I didn’t title this article...Stock Trading for Dummies. That’s because Options are different. They are a form of contract on an underlying asset with an expiration date that gives the buyer the right to buy or sell a stock asset. But, there is no ‘obligation’ to do either.
There are other common examples of trading options in life too. Maybe you saw some land you want to buy. But you won’t have the funds until a couple of months. Maybe you'll find a motivated owner and they'll agree to sell the land to you at an agreed price 2 months from now.
You don’t have to buy it in the 2 month period, but you have the ‘option’ to. The landowner does have an obligation. They must not sell the property for 2 months in case you do want to exercise your option to buy. Nobody else can buy it during that time.
And if the land value doubled, he still must sell it to you at the agreed price. This is a simplified example of trading options.
Stock option agreements function exactly the same. But, instead of land, the underlying security is stocks in a traded company. The option contract guarantees the owner will sell the stocks to the buyer at an agreed price (strike price), within an agreed time.
In the case of stock options there is a fee for granting the option. The fee (premium) is a cost to you whether you decide to exercise the option or not. I’ll discuss premiums further below.
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Here's a brief introduction to put options and call options for trade options.
What are ‘Calls’ and ‘Puts’
I could write a small book on this section, named ‘Call and Put Options for Dummies’. But I’ll summarize enough here for you to grasp the concepts.
Imagine you have an Apple option for a date 2 months in the future where the strike price is $150. So, are you allowed to buy at $150 or sell at $150?
So, you have the right to buy an Apple ‘Call Option’ for 100 shares at $150 per share. Or, you have the right to sell an Apple 'Put Option’ of 100 shares of Apple at $150 per share.
Deciding whether to Call Option or Put Option is determined by what you think the market for Apple stocks will do. Will Apple stock be above or below $150 per share on or before the strike date?
If an underlying stock like Apple improves in value it may be is $160 on the strike date. If you have a call option you can buy the Apple stocks at $150 and sell them at $160 for a profit of $10/share x 100 shares = $1,000.
So, if you believe Apple stock with dip to $140 by the strike date, you will place put options for $150. Then when the strike date arrives you can exercise your right to buy the stocks at the agreed $140. Then sell them at $150 for a profit of $10/share x 100 shares = $1,000.
In other words a call option let’s you can buy an underlying asset low and a put option let’s you sell high.
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Earlier I mentioned that to get an option there is a premium involved. The cost of buying the option contract. It's very important for options traders to be aware of these premiums.
The cost of an option on an underlying stock is a combination of two primary factors. The difference between the current stock price (Intrinsic Value). And the strike price and the amount of time left until the expiry date (Time Value).
A call option has intrinsic value when the current market price is higher than the strike price. A put option intrinsic value depends on how much lower the current market price is than the strike price.
If the current market price of Apple shares is $100 and I pay $5/share for an Apple stock option. If the strike price is $103 then the intrinsic value is $3 and the time value is $2.
If the stock price remains at $100 until the expiry date the time value vanishes. But I can still sell the stocks at $103 because only the time value decays...not the intrinsic value.
What is a Binary Option?
Binary options are simple options contracts with a set risk and set reward.
From the options trader’s perspective, they make a choice about whether a certain stock will go up or down over a set time. The options trader is betting his or her money on their prediction.
The trader can see how much money money will is earned if their educated guess is correct. When a trader guesses correctly they receive the money they risked...and a return on top. The options trader’s returns are usually big (70-85% is common).
Binary option contracts have three key ingredients (expiry time, strike price, and payout offers).
Option Spreads Reviewed (Option Spreads for Dummies)
An option spread occurs with the purchase and sale of options of the same class of stock, at the same time, although with different expiration dates and strike prices.
An option spread that uses a call option is a call spread. Put spreads use put options.
Options traders use spread options spreads to lower their cost of doing a trade.
Use Knowledge As Your Asset For Trading Options
Options contracts provide traders with a greater choice of ways to express a market view. Since options can add considerable complexity to your trading activities, you will want to educate yourself thoroughly about how to best use them so that they boost your bottom line as an options trader.
You may want to take an options trading course, read relevant articles, watch related tutorial videos and even hire an options trading mentor. Your online options broker could also provide you with its guides and tips to train yourself with, so check to see what it offers.
Due to the big financial risks involved involved in options trading, a real Options Dummy needs to accept the title. They also need to take responsibility for educating themselves about options trading.
There is no such thing as profitably trading options for dummies unless you want to lose big money on an underlying asset.
If you're still dubious about going head deep into trading without knowing your way around, I'd highly recommend you consider Bob James' Forex signals as he has over 10+ years experience in the markets and aims for 350 pip monthly average!
The information presented here is the tip of a big options trading iceberg. It gives a light introduction and some awareness of the complexities of options trading.
If trading options interests you, I suggest you enroll in a comprehensive training course and become fully prepared for the ride!