Options Trading for Beginners

Option trading is a unique opportunity for investors of all levels. Certainly many sophisticated traders are comfortable with this financial instrument, but newcomers to options trading should know a few things before jumping in. This article will provide some fundamental information about options trading for beginners.

Let’s begin with the basics: what is an option?  An option is an agreement that two parties create regarding one underlying asset. The underlying asset, in the case of stock options, is simply a collection of stock. That’s not all too puzzling for something with a fancy name—an underlying asset is really just something like 100 shares (one contract) of Google. The terms of the agreement truly make all the difference when trading options.  That’s one reason you need a good option trading for beginners course before attempting to trade options on your own.

The goal when purchasing an option is to predict the fluctuation of the underlying asset—the future stock price of the company. With a call option, the buyer purchases the right but not the legal obligation to purchase the underlying asset at any point in the future prior to the expiration date, so long as they pay the “strike price” for the asset. The strike price is agreed upon at the time of exchange and cannot be changed until the option is exercised (the buyer purchases the stock at the strike price) or traded away. That means if the underlying asset does not exceed the strike price, the buyer of the call option should not exercise.

Say you buy a call for 200 shares of Google (= 2 contracts) with a strike price of $650/share and an expiration date of June 1st. This means that any point before June, you can buy the 200 shares at the strike price. This can be very lucrative if, for instance, the actual value of the asset skyrockets to $750/share. You would, in this hypothetical case, save $100 for every share. That’s a big discount and can be used to make large sums of money in the market.  If the underlying asset’s value decreases to less than $650/share, it would make very little sense to exercise the option and pay the strike. In this situation, you can simply let the option expire. You do not need to exercise the option as you’ve already paid a premium fee to the seller of the call option. Your risk is limited to this premium.

Alternatively, you can always trade an option. If the underlying asset’s value is more than the strike of your call option, you can sell the option in the market. The option’s value increases as the asset’s value exceeds the strike. This means you can simply sell the option and make the same profit.

Hopefully this short “Options Trading for Beginners” article will help you begin the research and education process of your options trading pursuit.

by: Tim Warren

Related Pages

Options Education

Options Trading Seminars

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