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Calls: an agreement that provides the owner the right to buy a security at a specific price before the expiration date. A call owner would profit when the asset goes up in value past the strike price.
Puts: an option contract that provides the owner the right to sell the security at a specific price before the expiration date. A put owner would profit when the asset goes down in value past the strike price.
Strike Price: the price that the contract was exercised.
Contract: an agreement to buy or sell an asset at a predetermined price and time. (Typically 100 contracts will be executed in agreement.)
Expiration Date: the last date that the contract is valid. (Investors will lose all investment after this date passes.)
Premium: the total cost of purchasing an option contract.
At-the-money: call option & put option (strike price is the same as market's value of the asset).
Out-of-the-money: call option (strike price is above the market's value of the asset); put option (strike price is below the market's value of the asset).
In-the-money: call option (strike price is below the market's value of the asset); put option (strike price is above the market's value of the asset).
Options can be quite freighting to a beginning investor. However, it offers tools that can make you a better investor than without them. Many professionals in the industry utilize options to help mitigate losses in current positions and capitalize on extreme volatility.
Options consist of a type of derivative since the price of the option is linked to the price of another asset (commodities, bonds, stocks, etc.). Listed options (companies on NYSE & NASDAQ) are traded on the Chicago Board Options Exchange, each listing consists of 100 shares of stock. Options give the owner the right to either buy or sell the underlying asset in a contract at a certain price (premium) at a future date. The contract expires at a certain date; the owner must exercise the option contract before this date expires. There are several different strategies to maneuver your profits in using options.
Options trading offers several different opportunities when investing. A few being:
- Owning puts against a stock you are long, if you believe the stock will go down in price for the short term (earnings, catalyst, etc.)
- Owning puts against the QQQ if you believe the technology sector is too overvalued and is due for a selloff.
- Owning calls on a stock that has a large stock price to capitalize on the underlying value without risking a large amount.
Options offer gigantic returns to investors without large amounts of capital, as well as allow you to positio yourself to brace for selloffs by owning puts. There are plenty of other methods to make profits. However, in the effort to make this article an ease into the options world, those strategies are left out.
A suggestion would be to utilize 5 percent of your total assets to purchase contracts. This will mitigate major risks and have the ability for massive returns. In times of volatility, it may not be the easiest thing being long a stock, especially with companies with massive short interests. Options, on the other hand, thrive in times of craziness.
An easy to use platform that helps explain options while you are in the middle of the trade would be Robinhood, with a bonus of taking no fees. Tuning into the television show Options Action on CNBC is also helpful. This show breaks down options trading and recommends a few trades using options. Just remember to be careful with each investment made, since it is considered to be a risky investment.