You know what they sometimes say: if making a million dollars on Wall Street was an easy task then there would be millionaires everywhere you turn. This, obviously, is not the case. You’ll notice that very few people actually earn millions trading, but this does not mean it’s impossible. It just means it requires a lot of patience and dedication, paired with skillful strategy and research. Doing your homework pays when it comes to trading. Just take a look at trading options.
These securities offer traders a variety of benefits. They are great for growing capital and can result in huge gains. The only problem is that most people have no idea what options are, let alone the fundamentals of trading options. That’s why below I’ve compiled a simple “Trading Options for Dummies” guide to help prospective investors learn a little about the expansive world of options trading.
For one, let’s begin with what an option is. An option is a contract between a buyer and a seller. It states that the buyer may purchase an underlying asset (generally a number of shares of a particular stock) at a particular price any time before a given date and for a given fee. Okay, it sounds a little cumbersome, but illustration always helps when discussing these types of things.
For instance, if I told you that you could buy my house at any time in the next year at the price of $100,000, we would be in a similar contract. I would charge you a small fee for the right to buy the house whenever you want. If you choose to buy the house for $100,000 in this time frame, you would be exercising your option.
Now a few scenarios could play out from this arrangement. If my house’s value skyrockets in value and is now worth $200,000 on the open market, you could get a great discount by exercising your option. If my house becomes significantly less valuable, downgrading to a value of $50,000, you would pass and let the option expire.
Say you were charged a premium of $500. This would be the rate imposed for the option itself. This being the case, the car’s value would have to increase to over $100,500 in order for a profit to be made for its sale.
The locked in price of any underlying asset is known as a “Strike Price.” The last day on which an option is valid is known as its “Expiration Date.”
These concepts combine to create an average stock option contract. This simple “Trading Options for Dummies” guide however, merely scratches the surface of the intricate world of trading options.
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