Options can seem like a complicated investment product. Many resources break down the terminology and process. These plain English descriptions of options might appear to be options trading for dummies.
Options are contracts based on an underlying security like stocks. Investors can use options to purchase the underlying at a discount or protect the value of their portfolio by using options to guard against an underlying security the investor owns.
Many investors profit from options trading and do not buy or sell the underlying security. This is especially true if the investor expects a stock to have a significant move in value either up or down.
There are two basic types of options known as call and put options. Call options concern the right to buy the underlying security. Put options are based on the right to sell the underlying security.
The buyer of a call option has bought the right to sell the underlying security at the strike price stated in the option if the option is exercised by the expiration date. The buyer of a call option does not have to exercise the option.
The seller of a call option must carry through with the contract and buy the underlying security at the strike price if the buyer of the call option exercises the option. A buyer of a put option is buying the right to sell the underlying security at the strike price by the expiration date.
The buyer of the put is not obligated to exercise the option, but the seller must comply with the options contract and buy the underlying security at the strike price if the buyer chooses to exercise the option.
The value of a call option increases if the underlying security goes up in value. The value of a put option goes up if the underlying security goes down.
Most options traded are short-term options. However, options can have different time frames and be long term. Long-term options are called long-term equity anticipation securities (LEAPS).
Options trading strategies often involves spreads or trading combinations carried out at the same time. Some people consider options to be too risky. Educated investors know the risks before participating in a trade.
Strategies for trading options are often categorized as bull strategies, bear strategies, and neutral strategies. Bull strategies are used when the investor expects the underlying to increase in value. Bear strategies are used when the investor predicts the underlying will lose value.
Several websites for brokerage firms offer virtual trading software to allow investors to practice trading options before risking any real money on trades. The virtual trading can give investors practice on how options trading works and let them experiment with different strategies.
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