A Beginner’s Guide to Trading Options
Currency trading is an extremely risky endeavor due to price volatility. The slightest shifts in the Forex market can cause immense losses. But you don’t have to worry because you can protect your finances by trading options.
But before you dive into options, you must familiarize yourself with the basics. This article will get you started by answering important questions like: what are options? It’ll also introduce you to the options you can choose today.
What are Options?
An option is a contract connected to an underlying asset like stocks, foreign currency, or fixed-income products. It allows a trader to acquire or sell an underlying asset at a set price on a particular date. You should note that options are not obligatory.
Here’s an example of how options work. Suppose you believe a company’s shares will become more valuable over the next two months. In that case, you can capitalize on the expected spike in price by purchasing an option and selling it three months from today.
Types of Options
Common types of options today are:
- Call Options
A call option gives you the right to purchase an underlying security at the strike price (a predetermined price) before or on the expiration date. Buying a call option is advisable when you have enough reason to expect the asset to rise in price.
There are two types of call options: long and short. A long call option gives you, an investor, the right (but not the obligation) to buy a security at a predetermined future strike price. Conversely, with a short call option, a seller promises to sell an asset at a specific strike price.
- Put Options
Unlike calls, the value of puts increases in tandem with falling stocks. They also allow investors to sell underlying assets at a predetermined strike price before expiration. If you purchase a put option and the underlying security’s price falls below the strike price, you, the buyer, can exercise it and capitalize on the profit difference.
The good thing about a put option is it lets you profit from declining stock prices. But that comes with one significant risk. If you purchase a put option and the stock experiences an upward gain, you lose your money.
How to Pick the Right Options to Trade
Finding the right option is crucial because a slight mistake can lead to financial losses. To ensure you make the right move, do the following:
- Ensure you understand the underlying option
- Factor in your market outlook and favorite trading strategies
- Calculate your risk-reward payoff
- Evaluate the implied volatility
Key Takeaways
Trading options come with many benefits. First, it’s inherently less risky because it demands less financial commitment. Most importantly, options have unlimited upside potential and expose you to minimum losses. If you buy an option and things go sideways, you only lose the premium you used to acquire it.
Besides, you can trade options from the comfort of your home. You only need a digital device like a smartphone or PC, access to a good trading platform, and some money to invest.
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