Options Trading
Options give you the right — but not the obligation — to buy or sell a stock at a set price before a specified date, offering flexibility alongside managed risk.
Options Trading
Option Trading & investing
When most people think of investment, they think of buying stocks on the stock market, and many are probably completely unaware of terms like options trading. Buying stocks and holding on to them with a view to making long-term gains is after all one of the more common investment strategies. It's also a perfectly sensible way to invest, providing you have some idea about which stocks you should be buying, or you use a broker that can offer advice and guidance on such matters.
This approach is known as a buy-and-hold strategy and can help you increase your wealth in the long run, but it doesn't provide much, if anything, in the way of short-term gains. These days, many investors are choosing to use a more active investment style in order to try and make more immediate returns on publicly listed stocks.
Thanks to the range of online brokers that enable investors to make transactions on stock exchanges with just a few clicks, it's relatively straightforward for investors to be more active if they wish to. There are many people that trade online on either a part-time or a full-time basis — buying and selling equities regularly to try and take advantage of shorter-term price fluctuations, often holding their purchases for just a few weeks, days, or even a couple of hours.
Options Spreads
What really makes trading options such an interesting way to invest is the ability to create options spreads — the seriously powerful tools in equity options trading.
What is an options spread?
A spread is when you enter a position on two or more options contracts based on the same underlying stock — for example, buying options on a specific equity and also writing contracts on the same stock.
Why use spreads?
Spreads are used to either limit the risk involved with taking a position or to reduce the financial outlay required. Most options trading strategies involve the use of spreads.
There are many different types of spreads that you can create, and they can be used for many different reasons. Most commonly, they are used to either limit the risk involved with taking a position or reduce the financial outlay required with taking a position. Most options trading strategies involve the use of spreads. Some strategies can be very complicated, but there are also a number of fairly basic strategies that are easy to understand.
Selling & Writing Options
Two ways to sell stock options contracts
There are basically two ways in which you can sell options contracts. First, if you have previously bought contracts and wish to realise your profits or cut your losses, you would sell them by placing a sell to close order. The order is named as such because you are closing your position by selling options contracts.
You would usually use that order if the options you owned had gone up in value and you wanted to take your profits at that point, or if the options you owned had fallen in value and you wanted to exit your position before incurring any further losses on the underlying stock.
The other way you can sell options is by opening a short position and short-selling them. This is also known as writing options, because the process involves you writing new contracts to be sold in the market. When you do this you are taking on the obligation in the contract — if the holder chooses to exercise their option then you would have to sell them the underlying equity at the strike price (if a call option) or buy the underlying equity from them at the strike price (if a put option).
Writing options is done by using the sell to open order, and you would receive a payment at the time of placing such an order. This is generally riskier than trading through buying and then selling, but there are profits to be made if you know what you are doing. You would usually place such an order if you believed the relevant underlying stock would not move in such a way that the holder would be able to exercise their option for a profit.
Quick Reference
- Sell to CloseExit an existing long options position — realise profits or cut losses on a stock you own options on.
- Sell to OpenWrite a new options contract, taking on an obligation against the underlying equity in exchange for a premium payment.
- Call OptionGives the holder the right to buy the underlying stock at the agreed strike price before expiry.
- Put OptionGives the holder the right to sell the underlying stock at the agreed strike price before expiry.
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