Option trading is a practice of buying or selling options contracts, which are agreements that give the holder the choice to buy or sell a collection of underlying securities at a set price by a specific date. Options contracts are linked to an underlying asset, such as a stock or another security, and are good for a set period, which could be as short as a day or as long as a couple of years. When you buy an option, you have the right to trade the underlying asset, but youre not obligated to. If you decide to do so, thats called exercising the option. When you sell an option, you have an obligation to fulfill the contract.
Options trading can provide diversification and potentially limit the risk of loss, protect investments against market volatility, or turn a profit. Options trading strategies can be used for hedging, speculation, or profit, and deciding whether to buy or sell largely depends on your objectives. Options trading is popular with investors for a number of reasons, and certain options trading strategies can be used to amplify the potential upside benefit by using smaller amounts than would otherwise be required if trading the underlying asset itself.
Options trading can seem more complicated than it is, but its easy to understand if you know a few key points. Options trading involves two parties: the holder (buyer) and the writer (sometimes called the seller) . Holders are investors who purchase contracts, while writers create them. The holder pays the writer a premium for the right to sell or buy a stock by a certain date. This premium is usually a fee per share, and it’s also the maximum a holder can lose if the contract expires worthless.
Its important to understand the risks and downsides of options trading, such as the requirement for upfront premium payment and the potential to easily lose an unlimited amount of money. However, options trading can be a relatively low-cost way to speculate on a whole range of asset classes, and many brokers today allow access to options trading for qualified customers.
