Options Trading Overview

Description: Options Trading, Options Overview, Options Tutorial, Put Options, Call Options, Trading, Trader

Options trading has become one of the most popular trading vehicles on the stock market that gives great leverage without margin requirements. The same as with stock trading, in options trading we have two sides - the options seller and options buyer. The difference is that in case of the options, the options buyer by purchasing an options contract receives not a share of the company but the right (not the obligation) to buy or sell a certain amount of an underlying security. This right may be exercises within specified time period and at specified price.

There are two types of options: options puts and options calls. Options calls gives the right to buy a security at specified price within a specified timeframe and options puts give the right to sell an underlying security at a specified price within a specified frame.

In simple words, a trader who bought QQQQ options calls with $50.00 strike price that expires in December has the right to buy the QQQQ stock at $50.00 per share no matter how high above $50.00 the QQQQ stock runs. An options trader who purchased QQQQ puts at $50.00 strike price with December expiration has the right to sell the QQQ stock at $50.00 no matter how deep the market drops. In both cases an options buyer has the right to sell or buy an underlying security only until December (the expiration date of the purchased options).

On the other side we have an options seller who has the obligation to buy or sell an underlying security at a specified price (strike price) and within a specified period (until expiration date). It depends on an options buyer entirely whether or not to exercise options.

There are no margin requirements to buy options. No matter where the underlying security runs, an options buyer will never be a subject to margin calls.

An options buyer pays premium to an options seller for bought options. Until the expiration date, an options buyer can sell the bought options or exercise them. If none of this happened, the paid premium for options will be completely lost. In this case an options buyer looses 100% of the invested funds - maximum that could be lost by an options buyer.

An options seller is the subject of margin requirements and as a rule in order to sell options, a trader should have specified amount of funds. An options seller receives premium for the sold options that could be kept as a profit in case if the sold options expire worthless. At the same time an options seller faces a risk of unlimited losses when not just a received premium could be lost but much more.

Options trading delivers great leverage. Each options contract corresponds to 100 shares of the underlying security. If a trader buys 10 QQQQ options contracts at $2,000 per contract, he/she has to pay $2,000 for them:

10 contracts * 100 shares per contract * $2.00 = $2,000.00

In this case, by paying $2,000 only an options buyer manages portfolio of 1,000 QQQ shares. If at that time QQQQ shares cost $50.00 per share then a trader manages $50,000 portfolio and may receive profit or suffer losses equivalent to the investor who buys or sells 1,000 QQQQ shares. The only difference is that an option buyer has to exercise his right until options expiration (within specified period of time).

Some summary points:

• An options buyer has a right to buy or sell an underlying stock/security at specified price and within a specified period;
• An options seller has an obligation to buy or sell an underlying stock/security at a specified price and within a specified period;
• There are two types of options: Calls (call options) and Puts (put options);
• Each option corresponds to 100 shares of an underlying security;
• Strike Price is the price at which an underlying stock could be sold or bought before the options expire.
• Expiration Date is a date by which an options buyer has to exercise his right to buy or sell an underlying stock. The options expire on 3 Friday of the expiration month and after that an options buyer looses the right to buy or sell the underlying stock.

 

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