When you decide to invest in securities, you have a lot of choices. Options trading can be a great way to make some money and diversify your portfolio. Before you get started, learn a bit more about what options trading is, how it works, and some of the best strategies to use.
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What Is Options Trading?
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Options are contracts that give investors the option to buy or sell an underlying asset, such as an index, ETF, or security, at a predetermined price before the contract expires. These contracts are bought and sold on the options market. Like a majority of asset classes, options can be purchased with brokerage investment accounts. There are two basic types of options:
- Call options: Call options allow you to buy a specified number of shares at a certain price over a set amount of time.
- Put options: Put options allow you to sell a set number of shares at a certain price over a specific amount of time.
How Does Options Trading Work?
Options trading usually involves securities and takes place on the bond or stock market. When purchasing a call option, the stock option’s strike price is determined by the stock’s current price. When a strike price exceeds the share price of a call option, it’s considered “out of the money.” It’s considered “in the money” if the strike price is lower than the call option’s share price.
Put options, on the other hand, are considered out of the money when the strike price is less than the current share price. In either case, out of the money options are worthless once the contract expires. Options usually expire on Fridays, but the length of the contracts can vary from monthly to bi-monthly, quarterly, and so on. In most cases, however, the options contracts last six months.
What Are the Best Strategies for Options Trading?
When you have an effective strategy, there are plenty of opportunities to make money with trading options. Here are some tips for earning a profit while trading options:
- Do your research: Learn a stock’s history and future plans so that you can determine how much it is expected to rise.
- Evaluate a stock’s volatility: Think about the impact of large price moves on the underlying assets. Even if a stock moves in the desired direction, it could have the opposite effect on the price of the option.
- Diversify your purchases: Out of the money options are great because they’re cheap, but they can be risky. Instead of only buying out of the money or in the money options, improve your odds. Purchase some out of the money options to get a quick turnaround and a few in the money options that have a high likelihood of staying that way until the contract expires.
As with any type of investing, in options trading, it’s key that you have an understanding of the market and its trends. The more you know about the process, the more successful you will be.
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