If you want to embark on stock investment or trading, it will involve taking some risk. The more stable the stocks are, the less likely you are to lose money. If you want to exponentially increase a small amount of money, you can consider trading options. But, be careful as it is riskier.
Many people will advise you that trading options are for seasoned traders. Going in without a proper understanding of it can make you lose your money. You even need to pull some strings to buy options, so there is a lot to learn before diving into trading.
Here are eight important steps that every trader should know before they can consider trading options for a profit.
Understanding What Options REALLY are
If you look up options trading for beginners, you will find some confused people looking for answers. Look no further, as you are about to get a clear picture of options trading, right here.
Options are contracts that give you the right to buy or sell stocks at a certain price. These contracts last for a short period of time.
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If you buy an options contract, you can choose to use or “exercise” your right to buy or sell the stock at the said price within a given time frame.
Buying a contract gives you the option to trade those stocks at that price before the contract expires, but you are not obligated to use that option.
Two Main Types of Options
The two main types of options are call options and put options. If you buy a call option, you are given the right to buy a hundred shares at an agreed price.
You buy this option predicting that the stock prices will go up and above the agreed price. When that happens you sell options stocks at a higher rate then what you purchased, and making a profit with the price difference.
A put option is the opposite of the call option. It gives you the right to sell those stocks at the agreed price. You do so predicting that the prices will go down, you buy those stocks, and sell them at a higher price.
Learn Before Getting Involved
You must have extensive technical knowledge before you can start trading options at a profit. Learning the patterns and technical analysis is vital. That is why people say options trading is for experienced traders.
However, if you are willing to learn, you can also do well with trading options. You can learn from the knowledge and experience of others, through books, videos, and other online resources.
Become an expert by learning from experts. Writers who are also options traders, like Wendy Kirkland, have numerous books about patterns and technical analysis. Read these books to gain knowledge of options trading.
How Risky Are Options?
Having one options contract usually gives you the opportunity to buy or sell about 100 stocks of a company. You have to spend a certain amount of money on buying that option.
You are going to lose the money you are spending to buy the option no matter what. To make up for that loss, you have to hope that you can sell the stock at a higher price and make a profit that will be higher than the price of the option.
If you have that contract, you can buy stocks for a cheaper price. The cost of these stocks are usually lower because of their volatility and are riskier than others.
However, if you choose not to use your option, you lose nothing but the money you spent on buying that option.
Can You Curb Your Losses by Buying Options?
If you have a small capital to invest, you will want to curb your losses, which can be done using options.
Let’s say you are buying a call option contract for a hundred stocks and paying $500 for it. You were hoping that the stock prices will go up and you can gain from price differences. However, stock prices could go down.
Remember that you did not buy the stocks, you only paid for the right to buy them. Hence, the only money you lose is what you paid for the contract.
Using Options for Hedging
Most stock market traders know about hedging. Hedging is a risk management method traders use to check their losses. You can manage your risks through options and you can do so by using put options.
Traders use put options to insure their stock against a major loss. Let’s say you have invested in 500 stocks of a certain company. You do not want to sell the stocks right now, but you fear the prices will fall.
Just in case, you decide to buy five put options for the stocks during this period of time. If the prices drop during that period of time, going below the put option contract, you will be able to sell your stocks at a higher price using your contract.
Making Profit Through Speculation
If you can make technical analysis and understand patterns well, you can get a lot of profit through speculation.
If you are a do-it-yourself trader and make your trading decisions by yourself, then options trading is an excellent choice for you. However, you must make the right decision at the right time.
For example, in a bullish market, you can use call options to make a profit and in a bearish market, you use put options to make a profit.
However, your prediction has to be accurate. Don’t be disheartened if you experience loss every once in a while. The more you practice, the better your analyzed predictions will get. Be a mature trader and always look at the big picture.
Paper Trading For Success
Even if you gain all the book knowledge, you will not be successful until you get hands-on experience. Although many do not like to get their hands dirty, this is important since options trading can be risky.
That is why you need to gain experience through paper trading. A lot of investors use paper trading to practice before applying their experience to real-world trading.
You can find various apps online for virtual paper trading. You can try out various strategies and also get a safe way to check whether you are making accurate predictions or not. Once you feel comfortable with your experience and knowledge, you can start trading options for real.
Options trading is for calculated risk-takers. You do not have to be a seasoned trader, but make sure you have the knowledge and experience to trade profitably.