Stock options trading is one of the most popular trading styles that many traders around the world partake in. Understanding stock options trading starts with knowing what are stock options are, and that is key to the start of stock options trading.
Options are first representations of the underlying asset, and they are contracts that give the one who owns them the right to either buy or sell the contracts at the predetermined price also known as the strike price for a predefined duration of time.
What are Stock Options Trading?
So, when trading options, you should have two things noted down and well understood before you get to trading them; first, you should know the price you are buying or selling the options at, and second you should know the time you are going to buy the options at.
With the normal trading, you only should know the direction in which the asset will most probably move towards and that is it; the time can be at any time when the trade setup appears.
When the option contract that was bought earlier gets to the desired level of profit taking, the seller of the contract is obligated to take the opposite side of the trade when the contract owner decides to sell or buy the asset to lock in the profits.
Generally, options are a bit complicated even for the traders who have had involvements trading other markets. The rules that apply to trading stocks, commodities, ETFs, and any other assets will likely not work in the stock options trading.
Better Understanding, What are Stock Options Trading
There is a higher chance when you apply the normal sell high buy low scenario that works like a gem in other asset classes; you may find it a lot difficult to fit in the options trading.
That is why when trading options you should first learn that you can make money in options either the market goes up, down or it maintains a sideways action.
Options become a very important asset to the traders who have massive open positions on of the underlying asset and wish to hedge their positions using options as hedge trades that will cover for any losses that may be acquired.
Stock options are also very instrumental if you have a small capital base, you can be able to control massive amounts of an underlying asset with relatively small capital, and that is the catch in this business.
Trading is meant to be modeled around being able to have limited risks and at the same time have yourself able to make substantial gains.
The advantage with options is that if you are a stock trader you have stock options, for ETF traders there are ETF options, and most assets available in the market also have their options. That means it is easier for traders to carry on trading their preferred asset class and still trade options with it.
Stock Options Trading Terminologies
There are terminologies associated with stock options trading and it is important to know these terms so that you may know how the whole thing works.
When you want to buy stock options, that is called buying a call option. This means that you as the buyer you have the right to buy an asset at a particular price which is referred to as the strike price at a predefined time.
After you have bought the option, and it ends up in the money (ITM) or in layman’s terms in profit then you have the obligation to sell that asset at a price at a predefined time to the owner of but that is only possible if the call buyer is willing to buy at the price the stock is offered at.
If the call buyer does not agree on the price than you may end up holding on to the option and you must know that there is time decay and that causes you option to lose its value over time if it is not bought from you for you to realize your profits.
Stock options trading do not have shorting, but the act of selling short is called buying puts. If you are buying puts it means as the buyer you have the right to sell your asset when it hits a certain strike price and this should be done within a specific predefined time frame.
The owner or the person who sold you the puts is supposed or they are obligated to buy the asset from you at a price predefined and at the time earlier agreed, and all of this is dependent on of the owner will agree to buy the puts at that price.
Mistakes to Steer Away from in Stock Options Trading
There are many things that plague the stock options trading community, but some of these issues can be avoided fully to increase your chances for profitability.
As a new trader trading stock options, you should start out by buying the out of the money options. Most options traders say they are relatively cheap, but if you consider the number of times you will be holding a losing position, it is not worth the pressure and your money.
As an options trader, you should have different strategies for different market conditions; this may come as a surprise to many traders who have traded different instruments and have used the same strategy, and it has worked and used it on options, and it failed miserably.
The fact is trading options will always be different and different approaches will increase your profitability. Many traders plan for every stage of their trade and leave out the trade exit or what is the profit taking the plan.
This is a major problem because if you cannot come up with a solid profit taking plan them there is no real objective of being in the trade at all.
After you have gotten your entry it is important to have the exit predefined, and this should always be part of your plan. These are the common mistakes that if avoided your chance of profitability increase.