Options Trading For Beginners

In this blog post on options trading for beginners! we will introduce you to the basics of options trading and provide tips on how to get started. We will also cover advanced option trading strategies and provide you with helpful tips for success in this exciting and potentially lucrative field. So whether you are new to options trading or looking to refresh your knowledge, this post is for you. Let’s dive in!

What Is Options Trading?

Options trading is a trading instrument of financial derivatives that allow investors to buy or sell a specific security at a predetermined price at a future date. It is a contract that can be used by investors to hedge against market risk or speculate on the direction of the underlying security or market instrument. These contracts are typically bought and sold on exchanges, and they can be exercised at any time before they expire. There are two main types of options which are put options and call options.

Call options is a contract which gives its holder the right but not obligation to buy a security at a specified price, while put options is a contract that gives its holder the right but not obligation to sell an underlying security at a certain predetermined price. Options trading is complex yet it can be a potentially lucrative trading or investing instrument to its user because it allows investors to leverage their positions helping them to potentially achieve significant profits or losses. It is important for investors to thoroughly understand the risks and rewards of options trading before diving in.

What & How Options Trading Is Beneficial?

In this post about options trading for beginners, we aim at making its basics clear by analyzing one topic from various angles. This helps investors get a clear picture beforehand of what they can expect from trading options. We hope by knowing the benefits options trading offers, investors can plan for what it can be used for.

1. Options trading offers flexibility in investment strategy.

Options trading offers flexibility in investors’ investment strategies. Instead of simply buying or selling a security, investors can leverage options to hedge against market risk or speculate on the direction of that security or market. For example, an investor who is bullish on a stock can buy call options, which provide him/her the right to buy that stock at a lower price if the stock price moves in his/her predicted direction in the future.

Alternatively, Options trading also allows investors to leverage their positions, potentially increasing their potential profits or losses. For example, an investor who is bearish on a stock and is certain that this is only a short-term movement and the stock will rise, can buy put options instead of liquidating his spot position so that he/she has the right to sell that stock if the market doesn’t react to his expectation.

Additionally, option contracts have expiration dates, allowing investors to choose the length of time they want to hold their position. Overall, options trading offers investors a range of options and the ability to tailor their investment strategy to fit their specific goals and risk tolerance.

2. Allows investors to hedge against market risk.

Options trading is a tool that can be used to protect against market risk. They can safeguard their portfolios from any losses brought on by market volatility by buying different forms of options contracts.

For example, an investor who is worried about the fall in oil price can buy put options. If the price of oil starts to decline as expected, he/she can gain from this position, helping them to offset the losses that arise on the spot holding of his/her portfolio.

As an alternative, a trader who is concerned about the possible rise of a particular instrument can purchase call options on it. Options can be used to protect against risks that could occur with other instruments of the capital market, such as changes in interest rates, changes in foreign exchange rates, changes in the price of cryptocurrencies, or changes in the stock market. Overall, options trading aids investors in risk management and portfolio protection against prospective losses.

3. Can generate income through options premiums.

Options trading can also be used to generate income through options premiums. When an investor buys an options contract, they have to pay a premium to the seller of the contract. This premium is the price of the contract and income for the seller. If the buyer of such an option decides to exercise their option, the seller must fulfil the obligation he/she took while selling the contract to the buyer at that predetermined price. However, if the option expires without being exercised, the seller keeps the premium as their income.

Investors can opt to sell options contracts and earn income by way of premiums. This is called selling options, and it can be a lucrative strategy for investors who are willing to take on the risk of potentially having to fulfil the obligation to buy or sell the underlying security.

Overall, options premiums can be a source of income for investors who are knowledgeable about options trading and willing to take on the risks.

4. Provides an opportunity for speculative gains.

Options trading provides investors with the opportunity for speculative gains. Gains with this can be made in both directions of the market. For example, by buying call options, one speculates that a particular security or market will rise in value and potentially achieve significant profits if this speculation plays out. On the other hand, investors can also speculate that a security or market will fall in value and potentially profit from the decline by buying put options in the bear market.

Options trading also helps investors to leverage their positions, potentially increasing their potential gains or losses. However, it is important for investors to thoroughly understand the risks and rewards of options trading before diving in, as there is always the possibility of loss. Additionally, it is important for investors to carefully research and select a proper strategy that fits their specific goals and risk tolerance.

Overall, options trading provides investors with the opportunity to gain by speculating on either direction of the particular security or market moves and potentially achieve significant gains.

5. Can be used to generate leverage in the investment portfolio.

Options trading can be used to gain leverage in an investment portfolio. By buying options contracts, investors can leverage their positions, which have the potential to increase their possible gains and at the same time exposes them to possible losses.

For example, an investor who buys call options is betting that the underlying security or market will rise in value. If the security or market does indeed rise in value, the investor can achieve significant profits from the leverage provided by the options contract. Similarly, an investor who buys put options is betting that the underlying security or market will fall in value. If the security or market does what he/she expected, he/she can earn profit from such a decline. However, It is important for investors to carefully consider the risks and rewards of using options to generate leverage in their portfolios.

While it has the potential to increase profits, it also has the chance of increasing losses if the underlying security or market does not move in the expected direction. Overall, options trading is a powerful tool for generating leverage in an investment portfolio.

Types Of Options:

Though there are many types of options found in the market the major ones are call options and put options.

Call options:

Call options give the holder the right to buy a specific security at a predetermined price at a future date.

For example, let’s say that Company XYZ’s stock is currently trading at $50 per share. An investor believes that the stock will rise in value, so they decide to buy a call option with a strike price of $55 and an expiration date of three months from now. The investor pays a premium to buy the option, let’s say $2 per share.

If the stock does indeed rise to $60 per share within the three month period, the investor can exercise their call option and buy the stock at the lower price of $55 per share. The investor would then be able to sell the stock for a profit of $5 per share ($60 market price – $55 strike price – $2 premium paid).

If the stock does not rise above the strike price, the option will expire and the investor will lose the premium paid. Overall, call options can be a useful tool for investors who believe a security will rise in value.

Put options:

Put options give the holder the right to sell a specific security at a predetermined price at a future date.

For example, let’s say that Company ABC’s stock is currently trading at $50 per share. An investor believes that the stock will fall in value, so they decide to buy a put option with a strike price of $45 and an expiration date of three months from now. The investor pays a premium to buy the option, let’s say $2 per share.

If the stock does indeed fall to $40 per share within the three month period, the investor can exercise their put option and sell the stock at the higher price of $45 per share. The investor would then be able to profit from the decline in the stock’s value ( $45 sale price – $40 market price – $2 premium paid).

If the stock does not fall below the strike price, the option will expire and the investor will lose the premium paid. Overall, put options can be a useful tool for investors who believe a security will fall in value.

Binary Option

Binary options are a type of financial instrument that allow traders to predict the direction of the price movement of an underlying asset (such as a stock, commodity, currency, or index) within a specific time frame. The name “binary” refers to the fact that there are only two possible outcomes: the option either expires in the money (meaning the trader’s prediction was correct) or out of the money (meaning the trader’s prediction was incorrect).

For example, let’s say a trader purchases a binary option for $100 with a strike price of $1,200 for gold. The trader believes that the price of gold will rise within the next hour and chooses a call option. If the price of gold does indeed rise above $1,200 before the option expires, the trader will receive a fixed payout, usually between 60% and 85% of the initial investment. Let’s say the payout rate is 70%. In this case, the trader would receive a profit of $70 ($100 x 0.7 = $70)

If the price of gold does not rise above $1,200 before the option expires, the trader will lose their entire investment of $100.

It’s also important to note that some binary options platforms allow traders to close the position before the expiration time, either for a profit or a loss, depending on the current market conditions. For example, if the price of gold is rising and the trader believes it will continue to rise, they can choose to close the position early and take the profit.

In summary, when trading binary options, profit is calculated as a percentage of the initial investment, based on the difference between the strike price and the price of the underlying asset at the time of expiration, and loss is the entire initial investment if the prediction is incorrect.

There are also various other types of options, such as European options, which can only be exercised on the expiration date, and American options, which can be exercised at any time before the expiration date.

There are also combination options such as straddles, strangles, and spreads, which involve the simultaneous purchase or sale of both call and put options. By understanding the different types of options and how they work, traders can effectively navigate the options market and develop a customized strategy that fits their needs.

Steps On Getting Started As Options Trading For Beginners:

As a beginner getting started with options trading can seem daunting, but with the right tools and knowledge, it can be a rewarding and lucrative endeavor. Here are some steps to get started:

Set up a brokerage account:

Setting up a brokerage account is an important step for anyone looking to start options trading. A brokerage account is a financial account that allows investors to buy and sell securities, including options contracts. There are many brokerage firms to choose from, each with their own fees, services, and minimum deposit requirements. To set up a brokerage account, investors will need to follow a few steps:

1. Research brokerage firms: Investors should research and compare different brokerage firms to find the one that best fits their needs. Factors to consider may include fees, services, trading platforms, and reputation.
2. Gather necessary documents: Investors will need to provide personal information and documentation to open a brokerage account. This may include identification documents, proof of income, and any necessary paperwork required by the brokerage firm.
3. Open the account: Once an investor has chosen a brokerage firm and gathered the necessary documents, they can open the account by completing the brokerage firm’s application process. This may involve filling out an online form or visiting a brokerage firm’s office in person.
4. Fund the account: After the account has been approved, investors will need to fund it in order to start trading. This can typically be done through a bank transfer or by mailing a check.
5. Start trading: Once the account is funded, investors can begin trading options by placing orders through the brokerage firm’s trading platform. It is important for investors to carefully research and understand options trading before diving in.

Overall, setting up a brokerage account is a crucial step for anyone looking to start options trading. By carefully researching brokerage firms and gathering the necessary documents, investors can set up an account and start trading options to potentially achieve significant profits or losses.

We will be publishing the list of good brokers you can opt in for this process. If you want us to create a post or video on this with specific broker do let us know and we will try to help.

Research options and select a strategy:

Okay, you have now set up a brokerage account, the next step is to research options and select a strategy. This involves thoroughly understanding the options market and different options strategies in order to make informed decisions about what and when to buy or sell. Here are a few steps investors can take to research options and tips on how you can select a suitable strategy:

1. Educate yourself: You should educate yourself on the basics of options trading, including the different types of options, strike prices, expiration dates, and how profit and loss are calculated. There are many resources available for learning about options trading, including books, online courses, and financial advisors.
2. Research market conditions: You should update yourself with market news and conditions in order to make informed decisions about which options to buy or sell. This may involve researching individual securities or entire markets, analyzing technical and fundamental data, and following industry trends.
3. Select a suitable strategy: Once you gain a solid understanding of options trading and market conditions, you can select a strategy that fits your specific goals and risk tolerance. Options strategies can be as simple as buying call options on a bullish stock or as complex as implementing multi-leg options spread. It is important for you to carefully consider the potential risks and rewards of different strategies before implementing them.

Overall, researching options and selecting a strategy is an important step for anyone looking to trade options. By educating themselves on options trading and keeping up-to-date with market conditions, investors can make informed decisions and choose a strategy that fits their specific goals and risk tolerance.

Understand risk and manage position size:

Understanding risk and managing position size is crucial for anyone looking to trade options. Options trading involves inherent risks, and it is important for investors to carefully consider and manage these risks in order to maximize their potential profits and minimize their potential losses. Here are a few tips for understanding risk and managing position size when trading options:

1. Know your risk tolerance: Investors should know their own risk tolerance and choose options strategies that fit their risk profile. This may involve limiting the amount of money invested in options or using strategies that involve less risk, such as covered call writing.
2. Use stop-loss orders: Stop-loss orders can help investors manage risk by automatically selling options contracts if they fall below a certain price. This can help prevent significant losses if the underlying security or market moves in the opposite direction of what the investor had anticipated.
3. Manage position size: It is important for investors to carefully consider the size of their positions when trading options. This may involve limiting the number of options contracts purchased or using strategies that involve less risk, such as bull call spreads.

Overall, understanding risk and managing position size is crucial for anyone looking to trade options. By carefully considering their own risk tolerance and implementing strategies such as stop-loss orders and proper position sizing, investors can effectively manage risk and maximize their potential profits.

By following these steps, you can get started as options trading for beginners and build a solid foundation for your investment strategy.

Basic Concepts On Options Trading For Beginners :

Welcome to the section on basic concepts on options trading for beginners ! In this section, we will cover the fundamental concepts that every options trader should know in order to effectively navigate the market. This includes understanding strike price and expiration date, calculating potential profit and loss, and using options to hedge against market risk. By understanding these concepts, you can build a solid foundation for your options trading strategy and increase your chances of success. Let’s get started!

Strike Price:

The strike price is a key concept in options trading, as it determines the price at which the holder of an option can buy or sell the underlying security. For example, if a trader purchases a call option on a stock with a strike price of $50, they have the right to buy the stock at $50 anytime before the expiry of the option. If the stock price increases above $50, the trader can exercise their options and potentially realize a profit. However, if the stock price does not increase above $50, the option will expire worthless and the trader will lose their investment.

The strike price is typically expressed as a dollar amount, but it can also be expressed as a percentage of the underlying security’s price. For example, if a trader purchases a call option on a stock with a strike price of 100% of the stock’s current price, they have the right to buy the stock at its current price anytime before the option expires. This can be a useful way to speculate on the stock’s price without committing to a large upfront investment.

Overall, the strike price is a critical factor in options trading and can significantly impact the potential profit or loss of a trade.

Expiration Date:

The expiration date is an important concept in options trading. It determines the date on or after which the option can no longer be exercised. Options typically have a set expiration date, after which the option will expire and can no longer be traded. This date is typically set at a specific time of the month, such as the third Friday of the month.

For example, let’s say a trader purchases a call option on a stock with a strike price of $50 and an expiration date of three months from now. If the stock price increases above $50 within the next three months, the trader can exercise their options and potentially realize a profit. However, if the stock price does not increase above $50 before the expiration date, the option will expire worthless and the trader will lose their investment.

Overall, the expiration date is a critical factor in options trading and can significantly impact the potential profit or loss of a trade.

Potential profit and loss:

The profit and loss of an options trade are determined by the spot price of the stock at the time of expiration of the contract and the strike price of the option. By understanding how to calculate potential profit and loss, traders can better evaluate the risk and reward of each trade.

For example, let’s say a trader purchases a call option on a stock with a strike price of $50 and an expiration date of three months from now. The trader pays $2 per option as a premium or a total of $200 for 100 options. If the stock price increases to $60 at expiration, the trader can exercise their options and realize a profit of $10 per option, or a total of $1,000. The trader’s profit would be $1,000 minus the cost of the options, or $800.

On the other hand, if the stock price decreases to $40 at expiration, the trader will not exercise their options and will lose their investment. The trader’s loss would be the cost of the options, or $200.

Overall, understanding the potential profit and loss of an options trade can help traders make informed decisions about their positions and manage risk effectively.

Risk Management:

Risk management is an important aspect of options trading, as it involves the use of tools and strategies to minimize potential losses and maximize potential gains. By effectively managing risk, traders can increase their chances of success in the options market and achieve their financial objectives.

One tool commonly used for risk management in options trading is the stop-loss order, which allows traders to set a predetermined price at which their position will be automatically closed if the market goes against their prediction.

For example, let’s say a trader purchases a call option on a stock with a strike price of $50 and an expiration date of three months from now. The trader may set a stop-loss order at $45, which would automatically close their position if the stock price falls below $45. This helps to protect him/her against higher losses if the stock price declines unexpectedly.

In conclusion, understanding basic options trading concepts such as strike price, expiration date, potential profit and loss, and risk management is essential for success in the options market. By fully grasping these concepts and implementing effective strategies, traders can better navigate the options market and achieve their financial objectives.

Advanced Options Trading Strategies:

Understanding and effectively utilizing these sophisticated options trading tactics will improve your chances of making money and reduce risk in your portfolios. Before incorporating any technique into your trading strategy, it is crucial to completely comprehend the dangers and benefits that are presented by that particular strategy.

Some examples of advanced options trading strategies include:

Straddles:

A straddle is an advanced options trading strategy that involves a simultaneous purchase of call option and put option with the same strike price and expiration date. The goal of a straddle is to profit from market movements, either up or down, while hedging against potential losses.

For example, let’s say a trader is expecting a big move in the stock price of AAPL, but they are unsure which direction the stock will move. The trader could implement a straddle by purchasing a call option with a strike price of $130 and a put option with a strike price of $130, both with an expiration date of six months from now. If the stock price increases above $130, the trader can exercise the call option and potentially realize a profit and If the stock price decreases below $130, he/she can exercise the put and realize profit.

However, if the stock price does not move significantly in either direction, the trader may lose their investment. Straddles can be a useful strategy for traders who expect a big move in the market. Remember this strategy also carry the risk of losing the investment if the market does not move as expected. It is important for traders to carefully consider the potential risks and rewards of a straddle before implementing this strategy in their portfolio.

Strangles:

A strangle is an advanced options trading strategy that involves the simultaneous purchase of call option and put option with different strike prices but the same expiration date. The goal of a strangle is to profit from market movements, either up or down, while hedging against potential losses.

For example, let’s say a trader is expecting a big move in the stock price of TSLA, but he/she is unsure in which direction the stock will move. The trader could implement a strangle by purchasing a call option with a strike price of $122 and a put option with a strike price of $112, both with an expiration date of three months from now. If the stock price increases above $122, the trader can exercise the call option and potentially realize a profit. If the stock price decreases below $112, the trader can exercise the put option and potentially realize a profit.

However, if the stock price moves within the range of the two strike prices, the trader may lose their investment in the options.

Spreads:

A spread is an advanced options trading strategy that involves the simultaneous purchase and sale of options with different strike prices and expiration dates. The goal of a spread is to profit from market movements, either up or down, while hedging against potential losses. There are several types of spreads, including vertical spreads, horizontal spreads, and diagonal spreads, each with its own unique set of risks and rewards.

Vertical Spreads:

Vertical spreads involve the purchase of an option with a higher strike price and the sale of an option with a lower strike price, both with the same expiration date.

For example, let’s say a trader is expecting a moderate move in the stock price of XYZ Company, but they are unsure which direction the stock will move. The trader could implement a vertical spread by purchasing a call option with a strike price of $50 and selling a call option with a strike price of $45, both with an expiration date of three months from now. If the stock price increases above $50, the trader can exercise the call option and potentially realize a profit.

If the stock price decreases below $45, the trader can let the option expire worthless and potentially realize a profit from the sale of the other option. However, if the stock price moves within the range of the two strike prices, the trader may lose their investment in the options.

Horizontal Spreads:

A horizontal spread, also known as a calendar spread, involves the simultaneous purchase of an option with the same strike price and the sale of an option with a different expiration date. The goal of a horizontal spread is to profit from the difference in time decay between the two options while hedging against potential losses.

For example, let’s say a trader is expecting a moderate move in the stock price of XYZ Company within the next month, but they are unsure in which direction the stock will move. The trader could implement a horizontal spread by purchasing a call option with a strike price of $50 and an expiration date of one month from now and selling a call option with a strike price of $50 and an expiration date of two months from now.

If the stock price increases above $50 within the next month, the trader can exercise the call option and potentially realize a profit. If the stock price does not increase above $50, the trader can let the option expire worthless and potentially realize a profit from the sale of the other option. However, if the stock price moves significantly in either direction, the trader may lose their investment in the options.

Diagonal Spreads:

A diagonal spread, also known as a time diagonal spread, involves the simultaneous purchase of an option with a different strike price and expiration date, and the sale of an option with a different strike price and different expiration date. The goal of a diagonal spread is to profit from the difference in time decay and volatility between the two options while hedging against potential losses.

For example, let’s say a trader is expecting a moderate move in the stock price of XYZ Company within the next two months, but they are unsure in which direction the stock will move. The trader could implement a diagonal spread by purchasing a call option with a strike price of $50 and an expiration date of two months from now and selling a call option with a strike price of $45 and an expiration date of one month from now.

If the stock price increases above $50 within the next two months, the trader can exercise the call option and potentially realize a profit. If the stock price does not increase above $50, the trader can let the option expire worthless and potentially realize a profit from the sale of the other option. However, if the stock price moves significantly in either direction, the trader may lose their investment in the options.

Iron condors:

An iron condor is an advanced options trading strategy that involves the simultaneous purchase of a call option and a put option with different strike prices and the same expiration date, along with the sale of two calls or put options with different strike prices and the same expiration date. The goal of an iron condor is to generate income through option premiums or hedge against market risk while limiting potential losses.

For example, let’s say a trader is expecting a moderate move in the stock price of XYZ Company within the next month, but they are unsure in which direction the stock will move. The trader could implement an iron condor by purchasing a call option with a strike price of $50 and a put option with a strike price of $45, both with an expiration date of one month from now, and selling a call option with a strike price of $55 and a put option with a strike price of $40, both with the same expiration date.

If the stock price remains within the range of the two inner strike prices, the trader can potentially realize a profit from the option premiums. However, if the stock price moves significantly in either direction, the trader may incur a loss.

Covered call writing:

Covered call writing is an advanced options trading strategy that involves the simultaneous purchase of a stock and the sale of a call option on that stock. The goal of covered call writing is to generate income through option premiums while potentially realizing capital gains on the stock while limiting potential losses.

For example, let’s say a trader owns 100 shares of XYZ Company stock and is expecting a moderate increase in the stock price within the next month. The trader could implement covered call writing by selling a call option on the stock with a strike price of $50 and an expiration date of one month from now. If the stock price increases above $50 within the next month, the trader can exercise the call option and potentially realize a profit from the option premiums and the capital gains on the stock.

If the stock price does not increase above $50, the trader can let the option expire worthlessly and potentially realize a profit from the option premiums. However, if the stock price decreases significantly, the trader may incur a loss on the stock.

Protective puts:

A protective put is an advanced options trading strategy that involves the simultaneous purchase of a stock and the purchase of a put option on that stock. The goal of a protective put is to protect against potential losses on the stock while potentially realizing capital gains while limiting potential losses.

For example, let’s say a trader owns 100 shares of XYZ Company stock and is expecting a moderate decline in the stock price within the next month. The trader could implement a protective put by purchasing a put option on the stock with a strike price of $50 and an expiration date of one month from now. If the stock price decreases below $50 within the next month, the trader can exercise the put option and potentially realize a profit from the option premiums and the capital gains on the stock.

If the stock price does not decrease below $50, the trader can let the option expire worthlessly and potentially realize a profit from the capital gains on the stock. However, if the stock price increases significantly, the trader may incur a loss on the option premiums.

What Next For Options Trading?

Options trading can be a lucrative and exciting investment alternative, but it is important to approach it with caution and a well-thought-out plan. After learning this you need to keep in mind these tips:

• Start small: It is important to start small and gradually build up your portfolio as you gain more experience and understanding of the market.
• Educate yourself: It is essential to fully understand the risks and rewards of options trading before diving in. Take the time to learn about different strategies and concepts, such as strike prices and expiration dates.
• Use stop-loss orders: Stop-loss orders can help to minimize potential losses by automatically selling an option when it reaches a certain price.
• Diversify your portfolio: Don’t put all of your eggs in one basket. Diversifying your portfolio can help to mitigate risk and increase the chances of success.
• Don’t be afraid to ask for help: If you are new to options trading, don’t be afraid to seek out guidance from experienced traders or financial advisors.

By following these tips and approaching options trading with a plan, you will have an edge and increase your chances of success to achieve your financial objective.