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10 Basic Facts About Options Trading


Options Trading can be very exciting and rewarding. But you should not be trading options before learning at least some basic facts about options. Options are very different from stocks.  This article presents 10 basic options trading facts that every options trader should know. Don't start trading of you don't understand them.

1. Right to BUY or SELL

 

Options give you the right to buy or sell an underlying security at specific price. You can buy and sell options on a variety of different underlying assets including stocks, futures, indices, commodities, Forex, Bonds etc. Today most assets have options.

puts_options.png

 

2. Two Types of Options

 

There are two types of Options: Calls and Puts.

  • Call Option gives you the right to buy the underlying asset.
  • Put Option gives you the right to sell the underlying asset.

Generally speaking, you buy Call Option because you have Bullish Outlook and you buy Put Option when you have bearish outlook.

 

Though there are only two types of options, when you factor in other characteristics of options, there are endless trading possibilities.

 

3. Options Symbols

 

The OCC option symbol consists of 4 parts:

  • Root symbol of the underlying stock or ETF, padded with spaces to 6 characters
  • Expiration date, 6 digits in the format yymmdd
  • Option type, either P or C, for put or call
  • Strike price, as the price x 1000, front padded with 0s to 8 digits

Examples:

  • SPX 141122P00019500: This symbol represents a put on SPX, expiring on 11/22/2014, with a strike price of $19.50.
  • LAMR 150117C00052500: This symbol represents a call on LAMR, expiring on 1/17/2015, with a strike price of $52.50.

symbols.PNG

 

4. Buying an Option

 

If you buy an option, you are not obligated to buy the underlying instrument; you simply have the right to exercise the option. When you buy a Call Option, you have the right to BUY stocks at your option’s strike price.

 

Similarly, when you buy a Put Option, you have the right to SELL stocks at your Option’s price.

 

5. Selling an Option

 

If you sell a Call Option, you are obligated to deliver the underlying asset at the strike price at which the Call Option was sold if the buyer exercises his or her right to take delivery. If you sell a Put Option, you have to buy the underlying if exercised.

 

Generally speaking, if you don’t take any action, your friendly broker will most likely do it for you if your Options are eligible for exercise.

 

If you are not a member yet, you can join our forum discussions for answers to all your options questions.

 

6.Options have Limited Life

 

Options are good for a specified period of time after which they expire and the option holder loses the right to buy or sell the underlying instrument at the specified price. This specified period is called “Expiration”.

 

Options are available for variety of expiration timings such as Weekly, Monthly, Quarterly and much longer durations (known as LEAPs).

 

7. The Option Premium

 

The price reflects a variety of factors including the option’s volatility, time left until expiration, and the price of the underlying asset. There are several Options Pricing Models that you can use to calculate theoretical Option Price by modeling various parameters.

 

There is no fixed price for an Options. It is dynamic and will keep on changing with respect to time to expiration and other variables.

 

8. The Strike Price

 

You can choose any price at which you would like to buy or sell underlying instrument. These prices are called Strike Price and Options are available in several Strike Prices at, far or near the current market price of the underlying instrument.

 

9. Buying Means Debit

 

Options when BOUGHT are purchased at a DEBIT to the buyer. That is, the money is debited from your brokerage account. It’s exactly like Buying a stock.

 

10. Selling Means Credit

 

You can sell an Option, without owning the shares. Options when SOLD are sold at a CREDIT to the seller. Money is added to the brokerage account. You can’t withdraw this money until the trade has been closed. Usually, this money is used to offset the margin required for selling the options.

 

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