Calls And Puts: What To Know Before Trading Options – Guest Post
Because so many uneducated investors have lost millions of dollars trading options, they have a reputation for being a very risky investment vehicle. A solid education , and lots of time practicing with simulated trades is a good idea before jumping in to the options market with your hard earned dollars.
But here are a few key concepts to get you started:
Call options are the right to buy a certain stock at a certain price. Purchasing an option is typically done when an underlying security is moving up in price. This way, the option purchaser has the right to buy the stock at a lower price, and thus bring in a profit.
The risk to purchasing a call option is if the underlying stock decreases in price. The call option then gradually decreases in value and eventually becomes worthless.
Put options are simply the opposite of calls. They are most commonly used when the price of the underlying stock is headed down. The owner of a put option has the right to sell a certain stock at a certain price.
If the price of the underling stock falls, the holder of a put option can “exercise” it for a profit. Similar to calls, the risk of trading put options is if the price of the underlying stock moves in the opposite direction.
The premium is the price of an option.
Intrinsic value is how the option price, or premium, relates to the price of the stock. This is the actual value versus the market price. The intrinsic value of an option is referred to as either Out-of-the-Money (OTM), In-the-Money (ITM), or At-the-Money (ATM) depending on the strike price of the option.
Extrinsic value is also called “time value” and it refers to the value of time before option expiration. Out-of-the-Money (OTM) options are made up entirely of extrinsic value.
Option trading can be incredibly rewarding and incredibly profitable. But just like anything in the market, it does have risks. A proper understanding of options can be the starting blocks to a new and profitable future.
This guest post was provided courtesy of Jeffrey Ziegler, a full time father of five boys and an options trading fanatic.