Options trader definition

Equity options definition

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An option is not actually an asset itself, but an agreement.

It's what's called a derivative : a contract between two parties — an investor and a brokerage — whose value is based on, or derives, from an underlying financial asset, like a stock. In the case of options, this contract has to do with purchasing the asset.

How to Trade Options in 4 Steps

There are two types of options: calls and puts. A call option gives you the right to buy an underlying asset within a certain period, while a put option gives you the right to sell an asset within a period. Either way you have to pay for this right, and for the option. The cost of the option is known as its premium.

It's a per-share fee option contracts are typically for shares of the underlying security. The exact amount of the premium also depends on:. So buying an option is a bit like putting down a nonrefundable deposit on something — giving you the right to decide whether to actually buy it later. Options contracts typically run for no more than nine months. Options can be applied to a variety of securities, but equities are the investment of choice. The lower this strike price is in relation to the Big Tech Company's current price, the higher the premium you'll have to pay.

Conversely, buying a put option means that you're counting on the price of the Big Tech Company falling before the expiration date.

That's because your strike price ends up being higher than the actual price at expiration. Needless to say, if the underlying stock doesn't fall or rise the way you hoped, meeting or exceeding your strike price, you simply let your options contract expire. Remember, the option didn't obligate you to buy or sell anything, it just gave you the chance to. The only thing you will have lost would be the money you paid for the premium.

It's an easy, low-risk way to watch a red-hot stock — like electric car-maker Tesla was in late The idea of "controlling shares of Tesla stock for a fraction of the cost attracted many investors to options," says Moya. Hedge risk: If you own a big stake in a stock outright, you can use an options contract in order to reduce potential losses. For example, if an investor owns a significant number of shares in Company X, they can alleviate their risk by buying a proportionate number of put options on the same company.

By doing this, they have the option to defray some of their losses if Company X falls in price since the put option's strike price will likely be above Company X's actual price. Provide income: "You can sell puts and calls, which are conservative strategies to earn income on a position you own i. By selling either a put or call option, traders will pocket the premium paid by buyers. Bearish traders will sell call options in the hope that the underlying asset doesn't rise above the strike price, in which case they won't have to sell it. Conversely, bullish traders sell put options in the hope that the underlying asset rises above the strike price, in which case they won't have to buy it and can therefore pocket the premium.

Options trading is most suitable for more experienced retail investors, particularly those who carefully research their trades and have a predefined strategy.

Exercising Versus Selling

And there is a growing roster of places where they can trade options. Along with the established names Fidelity, Charles Schwab, TD Ameritrade , some of the best online brokerages for options trading for individuals include:. Options let their owners buy or sell a specific number of shares of an underlying stock at a specific price until a specific date.

They come in two main types — call buy or put sell options — and they can be for any kind of asset, although they're most commonly used with stocks. The main benefit of options trading is that it gives traders buying or selling rights over stocks for a fraction of their market price.

Call and Put Options: What Are They?

The fact that an option doesn't oblige you to trade the underlying asset means you have the choice of buying or selling only in favorable market conditions. Of course, options trading isn't without its risks. This is why they're better suited to institutions and the more experienced retail investor since they usually require research and the dutiful use of a hedging strategy. However, if due care is taken, options can be a highly effective means of profiting from the rise, or fall, in an asset's price. Just be ready to keep an eye on your optioned stock's moves, and be disciplined in your use of them.

Strike Price: Definitions and Uses for Options Trading

Says Moya: "Investors should ideally have predefined profit and loss targets on every options trade. For U. Buyers of European-style options may exercise the option— to buy the underlying—only on the expiration date. Options expirations vary and can be short-term or long-term. With call options, the strike price represents the predetermined price at which a call buyer can buy the underlying asset. The call buyer has the right to buy a stock at the strike price for a set amount of time.

For that right, the call buyer pays a premium. If the price of the underlying moves above the strike price, the option will be worth money it will have intrinsic value. The buyer can sell the option for a profit this is what many call buyers do or exercise the option receive the shares from the person who wrote the option. Writing call options is a way to generate income. However, the income from writing a call option is limited to the premium, while a call buyer has theoretically unlimited profit potential.

One stock call option contract actually represents shares of the underlying stock. Stock call prices are typically quoted per share. Therefore, to calculate how much it will cost you to buy a contract, take the price of the option and multiply it by Call options can be in, at, or out of the money :. You can buy a call in any of those three phases. However, you will pay a larger premium for an option that is in the money because it already has intrinsic value.

Put options are the opposite of call options. Here, the strike price is the predetermined price at which a put buyer can sell the underlying asset. The put buyer has the right to sell a stock at the strike price for a set amount of time. For that right, the put buyer pays a premium. If the price of the underlying moves below the strike price, the option will be worth money it will have intrinsic value.

🤔 Understanding an option

The buyer can sell the option for a profit this is what many put buyers do or exercise the option sell the shares. The put seller, or writer, receives the premium.

Writing put options is a way to generate income. However, the income from writing a put option is limited to the premium, while a put buyer can continue to maximize profit until the stock goes to zero. Put contracts represent shares of the underlying stock, just like call option contracts.

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To find the price of the contract, multiply the underlying's share price by Put options can be in, at, or out of the money, just like call options:.

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