Options is one of the main financial instruments that are derivatives based on the value changes of underlying securities such as stocks, within a certain time limit. An options contract offers Buyer a leveraged opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Different from Futures, the Buyer is not required to buy or sell the asset if they choose not to.
Advantages of Option Trading:
Cost Efficient – Leverage:
Options come up with a leveraged power. A trader or investor can get options position equal to a stock position at a much lower margin. For example, in order to purchase 200 shares of a stock at price $80, an investor requires paying $16000. However, if he was to purchase call options of equal weightage, the premium required would be around $4000, or even less than that.
High Return Potential:
The returns on options trading could be much higher than it from stock trading. As such, the option pays equal profit as the simple stock buying if had chosen the right strike. As we are getting options on lower margin and getting the same profitability the percentage return would be much higher comparatively.
The prices of Option are more fluctuate than Equities’ with its time sensitive features. There is a Due Date for any Option Contract, mostly Every Friday, or 3rd Friday of each month, and so on.
Option is used widely by both Institutional Investors and private investors for hedging and for profits too. In that case the risk from any combined positions is much lower, since the risk from Option itself is limited to the premium paid, and the risk for Equity is reduced because of the protected Option contract. And this is used frequently for temporary market adjustments.
Disadvantages of Option Trading:
Less Liquidity: That most stock Options have lower liquidity makes it difficult for a private trader to buy or sell at the best price.
Time Decay: The time value of your option premium decreases because of irrespective of movement in the market daily, and lost more when it is closing to the due day.
Non-Availability of all stock options: Not every stock registered have Option contracts because there is minimum price, volume, shareholder requirements.
High Commissions: The cost to trade Option is more expensive compared to future or stock trading generally. Some brokers charge commission based on the number of Contracts bought, and others charge differently based on the product, such as Option of Apple mostly cheaper than Option of CMG, etc.
Top 10 Liquid Stock Options:
- Apple (AAPL)
- Tesla (TSLA)
- Facebook (FB)
- NIO Limited (NIO)
- Palantir Technologies (PLTR)
- Boeing Company (BA)
- Plug Power (PLUG):
- Amc Entertainment (AMC)
- Alibaba Group (BABA)
- General Electric Company (GE)
Top 5 Liquid ETFs Options:
- SPDR S&P 500 ETF Trust (SPY)
- Invesco QQQ Trust (QQQ)
- iShares Russell 2000 ETF (IWM)
- Ultra Vix Short- Term Futures ETF (UVXY)
- ProShares Ultrapro Short QQQ (SQQQ)
4 Types of Options:
Buy Call: When you buy a call, you pay the option premium in exchange for the right to buy shares at a fixed price (strike price) on or before a certain date (expiration date). Investors most often buy calls when they are bullish on a stock or other security because it offers leverage.
Buy Put: Investors may buy put options when they are concerned that the stock market will fall. That’s because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset goes down.
Sell Call: An investor would choose to sell a call option if their outlook on a specific asset was that it was going to fall, as opposed to the bullish outlook of a call buyer. The purchaser of a call option pays a premium to the writer for the right to buy the underlying at an agreed upon price in the event that the price of the asset is above the strike price. In this case, the option seller would get to keep the premium if the price closed below the strike price.
Sell Put: An investor would choose to sell a put option if their outlook on the underlying security was that it was going to rise, as opposed to a put buyer whose outlook is bearish. The purchaser of a put option pays a premium to the writer (seller) for the right to sell the shares at an agreed-upon price in the event that the price heads lower. If the price hikes above the strike price, the buyer would not exercise the put option since it would be more profitable to sell at the higher price on the market. Since the premium would be kept by the seller if the price closed above the agreed-upon strike price, it is easy to see why an investor would choose to use this type of strategy.
What are the key factors that affect the price of the option?
The Value of the Security Product，Its Trend, and its changing speed are three main factors. These three factors we are explaining in our option course soon, since it is not easy to tell in few sentences here, with technical analysis and more details involved with the Company or the Product itself.
Time to Expiration: The effect of time is easy to conceptualize but takes experience before understanding its impact due to the expiration date. Time works in the stock trader’s favor because good companies tend to rise over long periods of time. But time is the enemy of the buyer of the option because, if days pass without a significant change in the price of the underlying, the value of the option will decline. In addition, the value of an option will decline more rapidly as it approaches the expiration date. Conversely, that is good news for the option seller, who tries to benefit from time decay, especially during the final month when it occurs most rapidly.
Interest Rates: Like most other financial assets, options prices are influenced by prevailing interest rates, and are impacted by interest rate changes. Call option and put option premiums are impacted inversely as interest rates change: calls benefit from rising rates while puts lose value. The opposite is true when interest rates fall.
Volatility: An increase in the volatility of the stock increases the value of the call options and also of the put option. Volatility that impacts call and put options in the same direction. Higher volatility means higher upside risk or higher downside risk.
If you want to learn more about options then you can enroll in our Result-Oriented Trading trainings.
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