Explain Option Trading:

A Brief Explanation of Option Trading

Have you been looking for good material or someone or a website that can explain option trading? If yes, you have come to the right place for us to explain option trading and hopefully you learn a few useful knowledge towards your trading success in option trading.

What’s an Option?

It is essentially a derivative (read: derived from) whose value is dependent on the price of a underlying instruments such as equities, futures, commodities, indices etc. In the case of equities, it almost always represents lot of 100 shares per contract (unless during stock splits). An option is a contract that is between a seller and a buyer, i.e. the seller sells the contract to the buyer.

What are the types?

There are two basic types of options contract, namely: Call and Put Option. From these two types of options, many names are coined and more exotic options combinations are traded.

What is a call option?

A call option gives the owner of the call the right but not the obligation to buy the underlying shares at a certain predetermined price (strike price) before a certain predetermined date (expiration date).

What is a put option?

A put option gives the owner of the call the right but not the obligation to sell the underlying shares at a certain predetermined price (strike price) before a certain predetermined date (expiration date).What is the option premium?

The option premium is the amount paid by the buyer to the seller in order to own the option.

What do the terms at-the-money, in-the-money and out-of-money mean?

An option is at the money when the underlying stock is traded close to the exercise price. A call option is in-the-money when the stock is traded higher than the exercise price and out-of-money when the stock is traded lower than the exercise price. Conversely, a put option is in-the-money when the stock is traded lower than the exercise price and out-of-money when the stock is traded higher than the exercise price.

Can an option be sold without owning the underlying?

Yes – an option can be sold without owning the underlying. However, there are risks involve and it is important that you do not over leverage when selling options. Also, you have to be right about the direction of the movement of the underlying as well as the exact timing of when it will happen.

What is open interests?

It is a measure of the number of contracts that have been initiated and have yet to close out. It is also an indication of the liquidity of the option contract which will affect the bid ask spread. Higher open interests imply more participants and therefore resulted in tighter bid-ask spread.

Explain Option Trading: Why trade Options?

For most individual investors, trading of put and call option are common although there are other various reasons for options trading, from hedging to speculation to arbitrage trading for large institutions. Option also provides some form of leverage, which is essentially a double edged sword, i.e. it could magnify your returns and losses, the extend of which depends on the position size you take.

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