What is Options Trading? Intro to Options Trading | CFI JO
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Options trading for beginners

What is options trading?

Introduction

Options contracts, or simply options, are agreements that give the holder the right, but not the obligation, to buy or sell a specific amount of an underlying security at a specified price at or until a defined time in the future. Options are derivative instruments because their value depends on the value of their underlying asset. Further, options are “decaying” or “wasting” assets because, all other things being equal, their value will decline over time until they expire. All assets depend on some definition of value, which is then modified by supply-and-demand factors established by buyers and sellers. However, options depend on many other variables, the most notable being their strike prices and the time left until they expire.

 

There are two major benefits for options investors. The first is leverage, or the ability to gain price exposure to a given amount of assets for a lower initial cost. The second is hedging a position in the spot market. For a small premium, the options investor has the right to buy or sell an asset at a specific price. They will have to pay that full price (or deliver the full amount of assets) at some time in the future but they can choose to close out their position before that happens. Therefore, they can profit from the move in the underlying asset for a lower cost, and therefore lower risk.

 

The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice.  Any view expressed does not constitute a personal recommendation or solicitation to buy or sell.  The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI.  Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.

Options Terminology

1-Call option: A call gives the holder the right, but not the obligation, to buy a defined amount of the underlying security at a certain price at or by a certain date.
2-Put option: A put gives the holder the right, but not the obligation, to sell a defined amount of the underlying security at a certain price at or by a certain date.
3-Strike price: This is the price at which the holder of the option may buy or sell the underlying security. For example, a call option with a strike price of 50 gives the holder the right to buy the underlying stock at that price no matter what the price of the stock may be at that time.
4-Expiration: The date at which the option holder no longer has any rights and the option no longer has value.
5-Premium: The price paid for the option.
6-Open interest: The number of options contracts outstanding per strike/expiration combination.
7-Exercise: Using the rights acquired under the option to buy or sell the underlying security.
8-In-the-money: A call option with a strike price below the price of the underlying; a put option with a strike price above the price of the underlying.
9-Out-of-the-money: A call option with a strike price above the price of the underlying; a put option with a strike price below the price of the underlying.
10-At-the-money: An option with a strike price at or very close to the price of the underlying.
11-American style: Options that may be exercised at any time up to and including their expiration date.
12- European style: Options that may be exercised only at expiration.

 

There are many reasons why an investor or trader trades options. The main reasons, as with other derivatives markets, is to hedge another position or to speculate on the performance of the underlying security.

 

1- Hedging: A hedge is like an insurance policy in that it can help to mitigate risk for a small fee. For example, a portfolio manager buys a large position in Company A. stock for its long-term pr