Last Updated on February 10, 2023 by Tabraiz
Trading has become digital now. Trading in the stock market refers to buying and selling financial assets, like, equities, mutual funds, bonds, etc., to make profits. Primarily online trading gets associated with stocks using a demat and trading accounts. If you want to trade other assets than stocks, bonds, etc., options can be the one. Starting with options trading may take a lot of work for beginners as it involves a high risk and reward ratio.
Let us understand what options trading is and its various important aspects for beginners.
What is Options Trading?
An option is a tradable contract where the trader can buy or sell the underlying security on a future date at a pre-specified price as per their choice and not as an obligation. It can be a stock, bond, other securities, or even indices.
Suppose the underlying security is stock. It is a stock option. The price of the given stock dictates the value of the option contract. Since they derive their value from other assets, these are called derivatives.
Options trading can be explained as speculating about whether the underlying asset’s price will go high or decline at a specific date, thus risky. You do not actually take the delivery of the underlying security. Therefore, you need not open demat account for options trading. A trading account allows you to trade options online. If you are investing in other tradings, you need to apply for demat account online before starting trading.
Important Terms To Understand Stock Options Trading
Stock options are listed on exchanges in the form of a quote. Following are the terminologies associated with options trading that a beginner should know to understand stock options quotes:
- Call Option and Put Option
- A call option means the right to buy the particular security at a preset price by a future date.
- A put option means selling the security at a pre-agreed price by a certain specified date in the contract.
- Strike Price: The strike price is the pre-agreed price of the underlying security.
- Premium: Premium is the price at which the trader buys an option.
- Expiry Date: An option has an expiry to exercise it at its strike price.
- Intrinsic Value: It is the difference between the underlying asset’s current and strike price.
- Extrinsic Value: The extrinsic value is based on elements other than the asset’s strike and the current price that impacts the premium, like the viability of the option.
- In-the-money and out-of-the-money. The profitability of an option depends on the asset’s price and how near it is to expiration. It can be in-the-money (profitable) or out-of-the-money (unprofitable).
Like, what is demat account and trading account, these are basic terms to know by options traders.
How Does Options Trading Work?
- Buying a Call
You can consider call options if you think the stock price will increase before the expiry date. After exercising the option, you can buy the stock at the pre-agreed price. Alternatively, you can sell the call option if the stock price goes above the break-even price.
- Buying a Put
If you think a stock’s asset price will decline before the expiration date, considering a put options contract is good. Suppose you buy a put option, and the underlying asset’s price falls below the break-even level. You need to exercise the option to sell the stock at the predefined price in the contract. Alternatively, you can sell the option to close the position. You will have the difference between the premium you paid for the contract and the current premium.
Thus, newbies can trade options with the right know-how. To conclude, trading call options means you are on rising prices, while trading put options means falling prices. Keep watching the stock movements and trade them without bearing the entire cost using your trading account.