Option Trading

Price is important in any transaction. It will determine if you have made enough money or exited at a loss. So it's important that you that find out if the price of the option is fair or not. This is calculated through an option pricing model, which provides a theoretical value for an option based on the variables that affect its price. Some variables can be calculated but others are based on the trader's assumptions.

Time value is one of the most important components in options trading. Options have an expiry date, so the value of an option depends on the time it has left. It's a speculative form of trading with a wasting asset, but with enough research to know what determines the value of an option, you will get an insight in how you can make the most out of your options trading. We will look into the factors that affect an option's time value, which is an integral part of options trading.

Expiry Date

Much has been said about trading options, especially its advantages and pitfalls. Some don't mind jumping in armed with their own research, confident that the market will move in their favour. Others prefer to step away leave the speculations to the risk takers. One of its most talked about features is it enables traders to earn in bullish, bearish and even neutral market conditions. More importantly it provides opportunities to earn big returns at a fraction of the cost of the underlying shares. We are going to look into what influences the price of an option.

Trading a variety of stocks and entering in different positions can be a tricky to manage. Unless you an experienced trader with a knack for multi tasking this can prove to be difficult. But there is a way that you can access the stock market in one transaction. The stock market offers a variety of financial commodities that you can trade other than the common shares. Trading index options is a good way to gain access to a wide range of markets.

Index options

The other black hole for traders, apart from falling share prices, is a neutral market. The price doesn't budge and settles in a limited range for a long period of time. During this time traders make little money and pay from dividends. They sell their position or hold in hopes that the share price moves up. Option offers an alternative to this scenario by buying call options over your stock. The bought call is covered by the shares.

Income

When a share falls in value, traders will either sell to cut their losses. They may incur a capital gains tax in the process, and miss the opportunity when the price recovers. Fortunately, you can use options to protect your investments. You don't need to sell, and still benefit from a rise in share price. With a put option, your shares are protected no matter how low the share price drops. Its a hedging strategy that enables you to compensate by making money in one market when you lose in another. Your put option offsets the risk of your share position.

How does it work?

Traditionally, traders make money from a rise in share price. Then when a bearish market comes around they stay out until the market recovers so they can buy back in. Trading options, on the other hand, lets you profit even when share prices fall. This can be done by buying put options. Its basically the opposite of buying call options. The more the share price falls, the higher in value the put options become. If the share market decides to take a different route and the share price increases, the put will lose its value, but the most you can lose is your premium.

Leverage

So far we have covered the advantages of buying call options, and pointers to help you decide which option to buy (or sell). Now we will cover the options that you can do when you buy the call. You don't really need to hold your position until it expires, as a matter fact most option positions close before their expiry date. You need to take one of these actions before the expiry date or your option will become worthless.

Sell your Options

Once you believe that the share price is on the rise, you will most likely buy a call option. Which one to buy will depend on two main factors that you have to choose, the exercise price and the expiry date. Deciding what expiry date you should settle for and the exercise price you want to lock in involves different factors that you have to look into.

Options: Exercise price

Shares are the most commonly traded commodity in the stock market, but there are alternatives that you can buy which can give you less risk and bigger chances for profit. If you are confident that a company's share price will take off, consider buying call options. As the share price increases, the call's value will follow suit, providing the opportunity for unlimited profits. The most you can lose if the price falls or stays steady, is the premium you paid. Here are the advantages that you can get when riding a rising share price when trading options.

Options Provide Leverage