It is easy to get scared off from the idea of trading options. First, there is the vocabulary. Futures, swaps, forwards, puts, and strike prices are ideas that make no sense on their own. Option strategies can be complicated. However, options trading is relatively straightforward. It all starts with understanding what might happen to an underlying asset. From there, you can begin the trading process.
An option is just a contract between the seller and the buyer. It lays out the future price of an asset, like a stock.
As with all contracts, both the seller and the buyer have obligations and rights. Buyers want to pay the least amount for the option. The seller wants to sell the option for as much as possible.
The two main types of options are puts and calls. A call gives the buyer the right to purchase a security at a predetermined price. A put provides the buyer with the ability to sell a security at a price that has been predetermined.
Stocks and options are different in a few key ways. Options have an exercise price and an expiration date. Stocks can come with shareholder rights and may pay dividends. Options do not. You can purchase options for a fraction of the cost of the underlying asset. According to SoFi Invest, “Options that exist for futures contracts, such as S&P 500 or oil futures, are also popular among traders and investors.”
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Trading direct assets, like stocks, can be appealing to beginners and long-term investors alike. However, if you like flexibility, options can work well for you.
One of the drawbacks of trading direct assets is that the price can plummet. You can lose a significant portion of your investment. This is why experts recommend using money that you won’t need for a few years when you invest in stocks.
Options, on the other hand, provide a tactical approach to investing. When you read the SoFi options trading guide, you see that options can provide a phenomenal return with a smaller investment. With options, there is a period associated with your investment. The expiration date on your options can range from days to several years. This makes it inherently shorter and attractive to traders who want to buy and trade regularly.
Options trading requires you to become familiar with a new vocabulary. This scares some people off. However, when you are familiar with some basic terms, you will see that trading options are not intimidating.
• Covered Call: This is a financial transaction where the investor who wants to sell call options buys the same amount of the underlying security.
• Married Put: This is where an investor holds a long position in a stock. They simultaneously purchase an “at the money” put option for the same stock. This protects them in the case of depreciation in the stock’s price.
• Bull Call Spread: this lets investors benefit from a minor increase in a stock’s price. Two call options are used to create a lower strike price range and an upper strike price. The strategy helps limit losses of owning stock but also puts a cap on potential gains.
Deciding if options are suitable for you is a personal decision based on your investing style. If you like an active investment approach, options may be appealing.
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