Options 101
Learning to Trade Options
Options are some of the most versatile and flexible investment instruments in the world. Although options are considered, by many, the most complex investment vehicles, they’re also some of the most lucrative. Once traders learn and understand the true power of options trading they never go back to just trading stocks.
Option derivatives have many advantages over other investment vehicles. Trading options can give the individual investor the flexibility to place bets on very specific market outcomes and conditions.
For example, an option trader can make a bet that in 2 months time a stock will be trading either above a certain price or below a lower price – placing a bet in each direction if you will. If the stock trades between these two prices in 6 months, the trader will lose a predetermined amount (limited risk) but can win an infinite amount, in theory of course. This type of option strategy is known as a Long Straddle or could also be a Long Strangle.
Option contracts also provide the individual investor with massive amount of leverage. In the US, 1 option contract represents 100 underlying shares. In other countries, such as Australia, option contracts can be in multiplies of 1,000 times the underlying stock or commodity. So, with a relatively small amount of money an option trader can control a very large underlying stock position.
Because of this, option trading is considered to be “very risky” but this is only true for the inexperienced option trader. In fact, when you master options you will realize that options are actually much safer than just trading stocks. Of course, option trading can make you very large returns in small amount of time, but trading options can also lose you the same amount if you are properly trained.
Options101 was written to introduce new comers to option trading terminology. As you go through the basics you will be exposed to key terms that will become clearer as you progress through this short course in option trading.
Option Strategies
After you have become more familiar with the basics of option trading, why not take a look at some of the possibilities of Option Strategies. This section describes the main strategies used by investment professionals.
Option Pricing
The Black Scholes Model is the most widely used option pricing model around. Generally used to calculate all of the option greeks. You can also use it to test risk/reward profiles for various option strategies to help you better understand option trading.
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