Options Trading Education

To successfully or at least decently transact on the options market you need to acquire an options trading education. This means that you have to familiarize yourself with a series of notions that lie at the foundations of this activity. Otherwise, you won’t be able to autonomously make decisions and expand your portfolio. The present article will therefore deal with the essential terminology used in this domain so that you can form an idea about it.

A solid options trading education starts with the explanation of the related vocabulary so that the novice trader can first understand the notions with which he later has to work. Here are the most important definitions one should take into consideration before starting to transact:

  • underlying security – it designates the stock that you buy or sell;
  • strike price -  it refers to the price you pay if you exert your rights;
  • expiration date – it is the date at which the option goes away, along with your rights;
  • option package – it represents the number of shares and name of the security that a trader calls away or puts to someone;
  • market quote – it refers to the most current price offered by purchasers to buy the option or asked by sellers to give up the option;
  • multiplier – it designates the number which is used to determine the amount of money you pay when you call away stock and the amount you receive when you put stock to someone; furthermore, it is also employed to establish the total value of the option;
  • premium – it is the total value of the option a trader buys or sells; it is calculated based on the market quote for the option and its multiplier;
  • exercise value – it denotes the cost a trader incurs when he exercises his call option rights; it is also called exercise cost; to obtain it, multiply the strike price by the multiplier.

Another milestone in the process of acquiring options trading education is to apprehend an option’s value. In order to understand how your investment is valued, you need to acknowledge the risks and rewards associated with it. In other words, you have to find out what makes it go up and what makes go down. Here are the main elements on the basis of which you can determine the appropriate market values for listed options:

  • the option type (is it a call or a put?)
  • the market value of its underlying security
  • the manner in which the underlying security traded in the past (volatile/calm)
  • the time remaining until its expiration.

A third essential requirement for completing your options trading education implies understanding options rights and obligations. These rights and obligations vary according to the type of option you work with. If it is a call option and you own one, you have the right to buy a certain stock at a specific price by a certain date. In capacity of put owner, you enjoy the right to sell certain stock at a specific price by a specific date.

It is at your discretion to decide what to do with these rights. Bare in mind that you don’t have to exercise them when the expiration date draws near. Instead, between the time you buy an option and the moment it expires, you can do:

  • sell it for profit;
  • sell it for loss;
  • exercise it;
  • let it expire with no value (for a loss).
If you plan to sell an option, you are obliged and committed to complete certain transactions. In order to meet these contract obligations, you have a more restricted range of options and choices. Thus, as the expiration date approaches, you can:
  • buy it back for profit;
  • buy it back for loss;
  • let it expire with no value (for a profit).

Before actually trading, one is recommended to get these notions straight because the theoretical background enables one to make decisions for long-term gains.

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