What Traders Should Expect When They Make the Move to Stock Options
For those looking to get into stock options, three things must be considered when taking a strategic approach to a derivative investment:
- Determining which way the stock will move
- How far the stock will travel in that direction
- The amount of time it'll take for the expected move to be made
Investing in options is different than stock due to the complexity and the many pricing factors. Stock traders only have to worry about how many shares and what price to pay. However, options traders must consider these factors along with several others that could affect the outcome of the trade.
First Things First – Getting Approved
Before getting approved to trade options, a broker must determine an options trader's qualifications as an investor. The investor will be required to submit specific details regarding their goals and skill level. These include:
- Experience with options and how many contracts the trader intense trade
- Goals, these might consist of income, growth, or preserving capital
- How active the trader is
- Portfolio size and overall wealth
- Which type of options trades the investor tends to make
When the investment bank has the required details, they can unlock the necessary level of options trading for the investor. In today's world, anyone thinking about getting an options trading should only consider a broker that provides advanced free software, dynamic trading, research, and support.
Once approved, the options trader is ready to jump in and make the more advanced trades that result in a higher return on capital.
Determining Which Way the Stock Will Move
Once the investor performs his research and decides on the direction of the stock, he can make his move. If he believes the stock will trade up, he can either buy a call option or sell a put option. Or, for more advanced traders, they can mix several options to maximize profit while reducing risk.
The owner of a call option gives a trader the right to buy stock at a specific agreed-upon price within a specified timeframe. The owner of a put option provides trader the right to sell stock at one particular agreed-upon price and within a specific timeframe.
This means that the trader believes the stock will drop, instead of selling the stock short like a stock trader would, the investor could buy a put option or sell a call option, and if correct, could enjoy accelerated returns on capital.
How Far the Stock Will Travel in That Direction
In order for the purchaser of an option to profit, the stock has to finish in the money. This means above the strike price for calls and below the strike price for puts.
For example, if a trader bought a 100-strike price call option and the stock traded up to $108, they would have the right to buy the stock at $100 even though it's trading $108. If they owned one contract, they could simultaneously buy 100 shares at $100 and then sell those 100 shares at $108, ultimately locking in a profit of $800 less the premium paid for the option.
A put holder would need the stock price to be below the strike price, here, for example, if a trader bought a 100-strike price put option, and the stock traded down to $91, the put holder would be able to sell 100 shares of stock at $100 and simultaneously repurchase the stock at $91, locking in a $900 profit.
The Amount of Time It'll Take for the Expected Move to be Made
Unlike stock, where the investor can simply hold it for as long as a desire, options all have an expiration date, which represents the date the holder of the option either exercises it, taking a position in the stock, or the option expires.
Expiration dates can be weekly, monthly, or span many years. The shorter the option contract, the more risk and the higher the reward if appropriately executed. These types of options are better left to the more experienced traders. Longer-term options give traders a more extended timeframe for the stock to move and become valuable. These can be great for all options traders but are specifically suitable for new investors who may be off on their timing.
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