Options allow you the flexibility to manage your risk at different levels. In case you are wondering if there is any space for options in your investment portfolio, you might want to know a little about what options actually are and how you could make money off them. Here is all you need to know about options trading.
What are options?
Typically, an option is a contract valid for specified time that allows the investor the right to buy or sell an asset (usually a 100 shares of the stock) at a predetermined price known as the strike price. The period of time could be anywhere between a single day to a couple of years depending upon the type of the option being invested in. The options are also often termed as a type of derivative security, given the fact that their price is internally linked to the actual price of another underlying asset (such as a share).
In a way, the options trading is based on your prediction of the market trends. For instance, you can buy an option to be bought or sold on a specific date on which you think the price of the stock might go up or down. When you invest in an option, you are being bestowed upon with a right to do one of the following things:
- Sell or buy shares at the strike price for a particular timeframe.
- Sell the option to another investor who might be interested.
- Do nothing and let the option expire without any financial obligation on you.
What are Call and Put Options?
An option can be broadly classified into two different kinds of contracts namely the Calls and the Puts. Here is what each implies.
Call Option- So when you buy the Call Option, you are essentially getting the right to ‘purchase’ the shares of a stock at a preset strike price within a predetermined time-frame.
Put Option- Alternatively, when you buy the Put Option, you can ‘sell’ the shares of a stock at a preset strike price within a predetermined time-frame.
Regardless of whether you go for a Call option or a Put Option, you then can then move in a particular direction, but not the obligation to do so. In case you do not wish to make the purchase or sale on the expiration date, you can simply leave it as it is and your option contract will become worthless. However, you will be losing 100% of the money that you had invested in buying the option in the first place.