Options Trading Basics Explained.
Trading options is a lot like trading stocks, but there are important differences. Unlike stocks, options come in two types (calls and puts) and these options are contracts (rather than shares) that give the owner the right to buy or sell an underlying security like a stock. Like stocks, however, options are traded on exchanges and individual investors can place orders to buy and sell through a brokerage firm.
Options trading isn’t new. In fact, the first listed options contract made its debut on the Chicago Board Options Exchange in 1973. While an option today is very similar to what it was at that time, many things have changed. The biggest difference is the size of the market in terms of investors, contracts traded, and numbers of exchanges. It has grown exponentially and there are more people trading options now than ever before.
Investors use options for a variety of different reasons. A call option is a contract that gives the investor the right to buy a stock at a set price for certain period of time. Some investors buy calls when they expect the share price to move higher. Others might sell calls when they expect the price of a stock to trade flat or move lower.
A put option represents the right to sell a security at a pre-determined price (the strike price) for a specified period of time. An investor might buy a put if they expect the price of a stock to move lower or as a protective position. A put seller is obligated to buy the stock at the strike price through an expiration period.
Puts and calls can be used in myriad of ways to create different potential risks and rewards scenarios. Complex strategies like straddles, butterflies and calendars lie outside the scope of this article, but regardless of the option contract or the motivation for buying and selling, the orders are submitted to a brokerage firm and then the transactions take place one of the exchanges.
The nice thing about some of today’s modern trading platforms, like thinkorswim® from TD Ameritrade, is they make it possible to place an order for even an advanced strategy with as little as one click. The options market does the rest.
Conclusion.
So, what is options trading? It’s simply the process of buying and selling put and call options. It can involve simple strategies like long calls or puts only. Or more advanced plays like butterflies and strangles. But, keep in mind, options trading is not suitable for every investor. In addition, be aware of transaction costs, especially when dealing with strategies that involve more than one contract as they can have a significant impact on any potential profits or losses.
TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.