What Is Options Trading?

Options trading is becoming more and more popular with investors, particularly recently where traditional stock market investments have not performed very well in general. Options give investors and traders the chance to speculate on the price of a financial instrument at a given point in time in the future. This could be above or below the current market price so there is money to be made even in falling markets.

To explain further, an option contract is basically an agreement between two parties to buy or sell a financial instrument at a certain price at a given point in the future. A call gives the holder the right (but not an obligation) to buy an agreed quantity of a security at a specific price at a specific time in the future and a put gives the holder the right (but not an obligation) to sell an agreed quantity of a security at a specific price at a specific time in the future.

So basically if you buying a call you are expecting the price to go up in the future and be above the contract price (commonly known as the exercise or strike price), and if you buy a put you are expecting the price to fall and be below the strike price at the expiry date of the option. If the price fails to reach the strike price up until the option expires then it simply expires worthless and all you have lost is the value of the option that you paid for. If, however, it exceeds the contract price, then you are in the money and will make more money the more the price exceeds this contract price either at the time of expiry or before that time when you realise that option.

Options are generally available at prices above and below the current market price. So for example if a stock currently trades at $50 then you could have the option to buy calls or puts with strike prices of $40, $45, $50, $55 and $60, for instance, and could buy calls or puts accordingly depending on which way you think the price will go up until the expiry date of the option. The option contracts that are already in the money, ie buying a call at $40 or $45 will come with more of a premium so will be more expensive than those out of the money, ie the $55 and $60 contracts.

This all sounds extremely complicated but it's quite easy to understand once you grasp the basics. You will soon discover why options are such a versatile and potentially lucrative trading instrument. If you are an investor they can help protect your share portfolio and capitalize on any short-term weakness in your share portfolio, whilst if you are a trader you can make substantial profits if your options trades are consistently in the money.

Furthermore you also have the option of writing and selling your own options contracts. This is a lot riskier because you could end up losing substantial amounts of money if an option expires deeply out of the money from your point of view, because you have to actually deliver the contract. So therefore a lot of capital is required in case of an options trade going badly wrong which is why we will mainly focus on the buying of options on this website where the risk is greatly reduced because all you can lose is the price of the options contrace if a trade doesn't go to plan.

I've only really scratched the surface of options trading in this article so for further information I suggest you read the other articles on this website or you check out the courses offered by Options University which are truly excellent. The Options 101 Home Study Course, in particular, is the best course to buy if you're new to options trading.