If you're thinking about trading stock options, you should first learn the different terminology traders use. Stock options can be complicated, and stock options sellers, also known as writers, accept a significant amount of risk. Gaining insight into the different aspects of options trading can help you understand if it's for you.
What Are Stock Options?
A stock option is a contract that gives someone the ability to purchase or sell stock at a specific price within a specific amount of time. While they have the right to buy shares of the stock, they are in no way obligated to buy or sell before the stock options expire.
What Is a Strike Price?
A strike price is the fixed price at which the options trader can buy or sell. The strike price is also often referred to as an exercise price. It determines the value of the option. For example, if the options trader owns the right to buy the shares, and the price on the open market goes above the strike price, then the option is worth value. If the open market price drops below the strike price, and the options trader only owns the right to buy, then the option is worth nothing and the options trader will lose money on the trade if the market price doesn't go up before it expires.
What Is a Call Option?
A call option is when the trader owns the right to buy 100 shares of stock at a specific price within a specified time frame. A trader usually buys call options if they believe that the price of a stock is going to go up.
What Is a Put Option?
A put option is a contract that gives the trader the right to sell an underlying security at a specific price within a set period of time. Options traders typically buy put options if they believe that the price of the stock will go down. If the price of the stock goes down, the trader can exercise their option and sell the stock at a higher price. The risk for the put option buyer is the cost of the premium that they paid for that option.
What Is an Options Straddle Versus Strangle?
Strangles and straddles are both options strategies that investors use to profit during trading. A straddle position is when a trader buys both a call and put option with the same strike price and expiration date. The trader stands to earn money regardless of which direction the market goes, however, the options only gain value if they make big moves, as the trader has to cover the cost of the premium for both options. A strangle option strategy is similar except the call and put options have different strike prices.
Learning about the different terminology and key strategies are important if you are considering trading options. Trading options can be a great way to earn income through the stock market. However, finding and sticking with a strategy is key to success.