How are Options Traded

Most people are quite familiar with the most common investment types, such as stocks, bonds, and mutual funds. But there exists another type of investment that offers an investor the opportunity to invest in a versatile manner that is easily adaptable to market movements. Options trading allows an investor the freedom of choice not often found in other forms of investments, granting the ability to be as conservative or as speculative as desired.

What is options trading? An option is a contract giving the purchaser the right to buy or sell an asset at a specific price by a specific date. It locks in a price for the purchaser, and is looked at as an entirely speculative venture. There is no guarantee the locked-in price will be beneficial, but the purchaser is optioning that price in the hope that market conditions will make buying or selling that asset on or before the option date profitable.

A good example of options trading would be an options transaction involving stock. Say that XYZ Corporation currently costs $10 a share. As an investor you feel the stock price will rise to $15 a share over the next year. You purchase an option to buy at $12 a share with an exercise date of 1 year. In doing so you’ve bought the opportunity to buy that stock anytime from the option’s purchase date to the exercise date for $12, regardless of the actual market price of the stock.

There are two types of options available for an investor: calls and puts. Buying and selling is conducted on the options market, in which there are four basic types of participants: buyers of calls, sellers of calls, buyers of puts, and sellers of puts.

Buyers are called holders while sellers are known as writers. An important thing to remember is that while the holder has no obligation to buy or sell at the agreed price, the writers do. A call gives the option holder the right to purchase the asset at a specified price before a specific date, while a put gives the holder the right to sell the asset at the specified price before a specific date.

Those who buy a call profit if the stock increases above the specified price before exercising the contract. Those who buy a put hope the price will fall before exercising the contract. Options prices are determined by a number of factors.

Those are the basics behind options trading. You should now have a general understanding of the uses of options, and the options market. The risk involved is largely determined in how much speculation is involved in the process, and at what price point the holder is willing to place the option. The smaller the price movement represented, the smaller the risk involved.