Recently, you may have found yourself interested in options trading. You are not alone in this, in fact, options trading has become more popular in recent years. It has hit a record high in the year 2020 with an incredible 7.47 billion contracts traded. That is an increase of a whopping 52.4 % from the prior year, this comes from the results of the Options Clearing Corporation. Whether you are a seasoned investor or just getting your sea legs in the game, both are helping options trading grow to new heights.
According to some, options trading can be a good thing. It can grow your income, it can limit what risk you take on. Plus, you can hedge against the market fluctuations all at once. Some places, like the finch brokerage Firstrade offers options trading that has zero commissions, zero options-contract fees, and no fees relating to deposits, inactivity, or maintenance. All of these within your portfolio can give you the opportunity to have more options than just stocks alone. Options also can act similarly to an insurance policy. How that works is that, for example, if your stock decreases, buying niche options can help eliminate losses that you potentially might have.
Options are able to lower the breakeven point as well as allow you to set a price for stock that is below its current market price. But, options trading is not always a straightforward gig. You need a strategy with your involvement.
What is an Option?
But, let’s not get too ahead of ourselves. Let’s back up a bit. What is an option? An option is a contract that gives the investor the “option,” to buy or sell any specific stock at a specific price for a specific period of time. When the time period ends, the option expires, and it no longer exists and has zero value. Another thing to note is that one who is operating within this caliber is not obligated to buy or sell. Options also do not have any sort of representation of ownership to the company it is in. Because it is technically a contact, it only represents the potential for ownership.
There are two kinds of options.
- Call Options: These allow the buyer to have the right to buy a specific number of shares, usually capped at about 100 of stock. Complete this at any time before the contract expires.
- Put Options: This allows the buyer to sell a certain number of shares of stock. It can also be done at any time before the contract expires.
Another thing to note is that while these options have a prolonged life, as they approach expiring, their value does start to go down. When the market is volatile it can also give more risk to the investor as the option can have little to no worth when it approaches expiring.
The Risks
Options trading is also well known as a risky gamble due to how complex the whole process is. Plus, how difficult it can be to understand it. That’s why it is best to understand how it works before you get yourself involved. You want to know what you are doing with your money so you don’t lose it.
The risks tend to depend on what your own role is in the contract. What side you are on, and what strategy are you going to use. Strategies can be based on how much time is left, market volatility and even interest rates all have a mark on options trading.
But, the good news is that you can lose a small prepaid amount if and when a trade moves against you. With how intense options strategies are, you may notice that some brokers will have extremely strict guidelines and credentials that require investors to meet.
Fortunately, there are online tools like the options profit calculator that can help traders analyze potential gains and losses before executing their strategies, making it easier to navigate the stringent guidelines set by brokers.
Should You Options Trade?
Now, the question is, is it right for you? Well, that depends all on what idea you have to accomplish before you do any options trading. A good start would be to do some calculations to discover what your maximum gains and losses are. Plus, what the break-even points of the strategies you are thinking of using. There are certain types of options trading calculators one can use online.
Once you are ready, you should look for a broker that has a low per-contract fee for options. Also, research what resources you are going to need that will help you guide yourself along in what strategies you are going to lose. An option for a novice would be Robinhood as they offer free-commission options trading as well as zero-commissions stock trades. However, it does not offer more interesting options and research capabilities that large brokers are able to do.
Conclusion
Now that you have a beginner’s idea of what options are. You can take that new knowledge and you can decide for yourself what you want to do with it. Good luck!
