Learning option trading is an important prerequisite to becoming a part of the fast-paced and potentially highly lucrative world of options trading. While it is not necessary to have a higher education in finance, a solid basic understanding of what options are and how they work is vital for anyone wanting to become involved in trading options.
What Are Options?
The first step to learning option trading is to understand what options are. Option contracts are often based on stocks, but are also available on other financial assets such as futures. A stock option is a contract which entitles the holder to buy or sell the underlying stocks on which the contract is based at a specified price (known as the strike price), at or before a certain date (referred to as expiration). The holder of the option contract is not obligated to exercise this right, and may also choose to sell the contract before expiration. Options are priced at a fraction of the underlying stock price, allowing a trader to control certain amounts of stock for a much smaller outlay than purchasing the stock outright.
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Types of Options
There are many types of options, but the most commonly used are classed as call options
and put options. These two types of options allow a trader to go with the price direction of the market, whether that movement is up or down. Basically, a call option is taken with the expectation that the stock price will rise, and the option will gain value in accordance with this. When a trader anticipates the stock price moving downward, they can take a put option, which increases in value along with the decreasing stock price. An important part of learning option trading is understanding these types of options, and knowing when to use them.
Deciding Which Options to Trade
A vital aspect of learning option trading is determining which options to trade. This can be done by using forms of stock market analysis. The most commonly used types of analysis are fundamental analysis, technical analysis, and sentiment analysis.
studies the intrinsic value of the company in which stocks are offered. Using this type of analysis can allow a trader to identify stocks with solid value that are being offered for a fair price. Options trading, especially if it is swing trading or day trading does not always place a lot of emphasis on this fundamental value, as gains are made from short term price movements.
Technical analysis, which is the study of price action with the aim of predicting probable future movement, is widely used in options trading. This form of analysis uses charts and indicators to calculate when prices are likely to continue moving in the same direction or to experience a reversal.
Sentiment analysis studies the overall outlook of market participants and uses this information to anticipate the likely movement of prices.
A combination of all of these forms of analysis provides the most solid method of selecting stocks on which to trade options, and clearly this takes some time and effort to learn and implement. For those individuals who do not wish to make trading a time consuming exercise, using a service such as the S.O.M.E. Armchair Trader Membership takes the hard work, and any guess-work out of deciding which options to trade.
Using Option Trading Strategy
Understanding what options are, the types of options that are available, and how to use analysis to decide which stocks to trade options on is a huge part of learning option trading. The next stage is implementing strategies including determining the best point to enter and exit the trade, and deciding on risk-management measures which include the use of stop loss orders. Another important part of option trading strategy is allocating an appropriate portion of investment capital to each trade in order to spread risk and maximize potential gain.
Learning option trading does not need to be difficult or daunting. Understanding the basic principles of what options are and how to use them, and utilizing the tools and techniques outlined in this article can help an individual make a great start to their option trading career.
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Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.
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