Options are a form of derivative, their value is influenced by the value of the underlying instrument. A stock could become the underlying instrument, but can also be an index, a currency, a commodity, or any other security. As now we know what are options, let’s look at the features of it.
Here are some of the features of an Option:
- Premium or down payment: In order to exercise an option transaction, the holder of this contract must pay a set sum known as the ‘premium.’ The premium money is forfeited if the possessor does not use it. The premium is normally subtracted from the total payoff, leaving the investor with the balance.
- Striking Price: The striking price indicates the price at which the option owner can buy or sell the underlying security if the option has been exercised. For the period of the contract’s validity, the strike price is fixed and does not change. It’s critical to remember that the strike price differs from the market price.
- Contract size: The contract size refers to the quantity of an underlying asset that can be delivered in an options contract. These figures are fixed for an asset. If the contract is for 100 shares, the holder must buy or sell 100 shares while exercising one option contract.
- Contract expiration date: Every contract has an expiration date. Until the contract’s validity expires, this stays the case. If the option is not exercised by this date, it will expire.
- Intrinsic value: The intrinsic value is the strike price less the current price of the underlying security. Money call options always have an intrinsic value.
Diverse asset classes are frequently seen in investment portfolios. Stocks, mutual funds, ETFs, and bonds are common Options Trading examples. Options are a different type of asset. Options trading, when handled correctly, provides various benefits that stock and bond trading alone can not.
Options Trading vs. Other Instruments: What are the Differences?
Traditional futures contracts used in stock, index, and commodities trading are regarded as higher-risk products, whereas options are considered lower-risk. This is due to the fact that an option contract can be walked away from or withdrawn at any time.
This also means that, unlike stocks, options do not imply ownership of a business. As a result, the option’s market price (also known as its premium) represents a percentage of the underlying security or asset.
What Is the actual Process of Trading Options?
- Purchasing options demands a lower initial investment than purchasing shares. The cost of obtaining an option (premium and trading fee) is significantly less than the cost of purchasing outright shares.
- Options trading allows investors to fix the price of their stock for a set length of time. The fixed stock price (also known as the strike price) guarantees that one can trade at that rate at any time before the options contract expires, depending on the type of option utilized.
- Options trading adds income, leverage, and even protection to a trader’s investing portfolio. A hedge against a declining stock market is a frequent approach of using options to limit one’s downside losses. Option trading can also be utilized to generate a regular stream of income.
- Trading options are fundamentally flexible. Traders can make a variety of smart moves before their options contract expires. Using options to acquire shares to add to their investing portfolio is one of them.
- Investors can also try purchasing the shares and then profitably selling some or all of them. They can also sell the contract to another investor before it matures and expires at a greater price.
How to Make the Most of Call Options:
A call option allows a trader to purchase a predetermined number of shares in bonds, stocks, or other securities such as indices and ETFs at any time before the contract expires. When buying a call option, you want the asset or security’s price to rise in order to profit.
This is because your call options contract allows you to buy the underlying asset or security at a cheaper rate than the market rate. As a result, when you utilize your call options contract to make a purchase, you get a discount.
Keep in mind, though, that you will have to renew your call option (usually on a quarterly, monthly, or weekly basis). This is why options are known to have a constant ‘time decay,’ which effectively indicates that their value decreases over time.
Look for lower strike prices in call options, as this indicates that the call option has more inherent value.
How to Make the Most of Put Options:
A put option contract allows an investor to sell a predetermined number of shares of an underlying security, asset, or commodity before the contract expires at a predetermined price.
Such contracts allow one to profit if the price of an asset or security drops in the future. The put option is used to sell underperforming shares at a predetermined price that is closer to the original price.
Put options can also be used to lower one’s net loss. Assume you purchase stocks worth Rs 2500 with a put option for Rs 2250 because you believe their market price will fall. If these equities underperform at Rs 2000 in a few months, you can sell them for Rs 2250, reducing your net loss to Rs 250 instead of Rs 500.
Put options, like call options, have a temporal value. Look for higher strike prices at first to locate an intrinsically valued put option.
