The financial markets can be a great place to make money. But it’s important to understand the risks involved, before you start trading options.
Options are contracts that give you the right – but not the obligation – to buy or sell a financial product at a certain price for a limited time period. They can be traded between private parties in over-the-counter transactions or exchange-traded in live, public markets. Options can be used to speculate on a market’s direction, such as whether stocks will rise or fall. You can also use them to hedge your portfolio, with a call option designed to protect your investments against a decline and a put option designed to guard against a rise. Options can be physically or cash-settled.
In addition to choosing which option trading options – Medium.com type you want to trade, you’ll need to decide how long you want your contract to last. The longer the term, the more potential profit you can make, but the greater your risk. It’s also important to understand how the premium (or cost) of an option relates to its chance of being profitable at expiration, taking into account the current price of the underlying asset.
Another thing to consider is how your view of the market will shape your strategy. With options, you can craft positions that express almost any view, from a short-term bearish outlook to an intermediate-term bullish one. You can also use options to take advantage of market inefficiencies, such as when a stock’s implied volatility is high.
In order to fully understand how the value of an option is determined, you’ll need to be familiar with a series of factors called “The Greeks.” Delta, gamma and theta all measure the impact that a change in the price of an underlying asset will have on the price of an option. Understanding how these variables interact can help you fine-tune your trades, and avoid mistakes that could cost you money.