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It can seem intimidating to learn options trading at first, but it really is easier than you think.
All you need is a few options trading basics and a little time to get comfortable. After that, you will be ready to take the plunge. Just make sure it's consistent with your own goals and risk tolerances.
Remember, you do not have to compete with the professionals to make money trading options. Let them run their complicated strategies. You, however, will learn to make a lot of money in little time, with minimal effort.
At the very least, you can trade options simply to hedge your stocks in case the broad stock market falls.
You see, options trading gives you flexibility. It can make you money from capital gains, and it can make you money by providing an income stream. Or it can simply provide insurance against losses.
The choice is yours. We'll start with the basics, and then we'll get into how you can harness options trading to carry out your specific financial goals.
The Basics of Options Trading
Much like a stock, an options contract is defined by the underlying company for the stock on which it is based. But, unlike stocks, options have a shelf life.
Options contracts expire by a predetermined date, called the expiration date, and that is what makes them far more interesting. You know exactly how much time your options strategy has to work. But if the option you buy meets your target profit early, you can sell it and reap your reward.
Options have four important components:
Type: There are two types of options, called "calls" and "puts." Call options give the holder the right, but not the obligation, to buy the underlying stock at a specified price – the strike price – by a set expiration date. Put options give the holder the right, but not the obligation, to sell the underlying stock at a specified price by a specified date.
Strike price: This is the price at which you can exercise the option. For calls, if the strike price is above the current price of the underlying stock, then it is "out of the money." If it is below the price of the stock, then it is "in the money." For puts, it is the reverse.
Expiration date: Also called the "exercise date," this is the date at which the option becomes null and void. It will either be in the money, in which case it is automatically exercised, or out of the money, in which case it expires worthless.
Premium: This is the price the buyer pays for the option. It is not the same as the money needed to exercise the option.
Everything else is a derivative of these four components, including the "Greeks," which are measures of how options contracts behave over time.
These are labelled with Greek letters, such as delta and gamma, and tell us how fast an option price moves based on time to expiration, the amount the option is in or out of the money, interest rates, and other factors. Needless to say, they can be useful in planning your trades. But you don't need to worry about them right now.
For the most part, as you learn, you will probably trade options that are at or near the money. That means they have strike prices very close to the current price of the underlying stock. Later, you can hone your strategy to trade different strike prices.
Now, let's get into how you can achieve your financial goals by trading options…