Learn About Options Trading to Diversify Investments
Trading with options is completely different than most other investment tools in that risk is controlled. Options bring an alternative investing opportunity to the volatile commodity and equity markets, as well as to the more predictable bond and currency markets. Take the time to learn about options trading, first the basics, and then more in depth information to either trade options online or diversify with a professional financial adviser.
What are Options?
Options are nothing more than contracts formed between two parties. One party pays a premium to have the option of making a purchase or sale at a given point in time. They provide a degree of security for investors, as a buyer or seller can essentially pay to manage risk. The cost of this lack of risk, in itself becomes the risk. Regardless of if the exchange ever takes place, the contract was paid for. An investor can partake in commodity options trading, equity, interest-rate, index, and currency options trading.
Learn Options Trading Basics
There are a set of terms intrinsic to this form of exchange. Learning these terms will help with a basic understanding of options trading.
- Underlying is a term used to describe the actual commodity, stock, or other investment instrument that the contract is based on. The quantity and expiration of the underlying is clearly defined in an options contract.
- The buyer refers to the party that is paying the premium for the option.
- The writer accepts the payment in exchange for the rights given to the buyer to buy or sell at the agreed upon terms.
- The strike price is the agreed upon price that the exchange will take place at, regardless of what the actual price is at the time of expiration.
- A put is a type of option that allows the buyer to sell the underlying.
- A call is when the buyer has the right to buy the underlying.
- Long the put or call refers to the belief that the price of the underlying will change enough for a profit to be made.
- Short refers to the belief that the price will not change at all, or not very much.
- When an option is ‘in the money,’ then it is worth it for the buyer to make the actual exchange; conversely, ‘out of the money’ means that the exchange is not worthwhile.
As an example of an options trade with commodities, if a buyer expects that the price of wheat will rise from $12 per bushel, to $15 at a given time, than they may try to make a deal with a writer, to buy wheat, the underlying, at a strike price of $13 per bushel.
This makes the buyer long the call, as they believe the price will rise by a certain amount, while the writer is short the call, expecting the price to remain the same, or only change a small amount. If the actual price of wheat ends of being $17 per bushel, than the buyer is in the money, and will go ahead with exchange, which is generally settled in cash, not the actual commodity. The buyer’s profit is the net worth of the underlying, minus the premium paid to the writer.
Learning Options Trading Online for Free
Options allow managed risk, but there is still risk involved. For the inexperienced investor, learning about options trading online is the wisest initial investment. There are many resources, some for a fee, while others are free. The Chicago Board Options Exchange (CBOE) offers a range of courses, from beginner to advanced, for no cost. CBOE is the original options exchange. Not only does this institution provide courses and information, but also access to data, which can be researched for potential investments.
Utilizing the unique opportunity of options is an ideal way to diversify investments for many active investors. The most effective tools for successful trading are patience, knowledge, and research. Use online resources to learn as much as possible about options trading.