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Best Options Trading Lessons In 2023 [Updated Lists]

Best Options Trading Lessons – Options trading is a form of investing that involves buying and selling contracts that give the buyer or seller the right, but not the obligation, to buy or sell an underlying asset at a specified price and time. Options trading can be used for various purposes, such as hedging, speculation, income generation, or portfolio diversification.

In this article, we will cover some of the basic options trading lessons that can help you get started or improve your skills in this exciting and potentially profitable market.

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What Are Options?

An option is a contract that gives the buyer the right to buy (call option) or sell (put option) an underlying asset, such as a stock, an exchange-traded fund (ETF), or an index fund, at a predetermined price (strike price) before or on a specific date (expiration date). The seller of the option, also known as the writer, has the obligation to fulfill the contract if the buyer exercises their right.

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The buyer of an option pays a premium to the seller to acquire this right. The premium is determined by various factors, such as the current price of the underlying asset, the strike price, the time to expiration, the volatility of the asset, and the interest rate. The premium is the maximum amount that the buyer can lose if the option expires worthless. The seller of an option receives the premium as income but faces unlimited risk if the price of the underlying asset moves against their position.

Options are classified into two types: American and European. American options can be exercised at any time before or on the expiration date, while European options can only be exercised on the expiration date. Most stock options traded in the U.S. are American options, while most index options are European options.

Why Trade Options?

Options trading offers several advantages over other forms of investing, such as:

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Leverage

Options allow you to control a large amount of an underlying asset with a relatively small amount of capital. For example, instead of buying 100 shares of a $100 stock for $10,000, you can buy a call option with a strike price of $100 and an expiration date in six months for $500. This gives you the right to buy 100 shares of the stock for $100 per share at any time before or on the expiration date. If the stock price rises to $120, you can exercise your option and buy 100 shares for $10,000 and sell them for $12,000, making a profit of $1,500 (minus the premium paid). This represents a 200% return on your investment, compared to a 20% return if you had bought the stock outright.

Risk management

Options can help you limit your risk or protect your existing positions from adverse price movements. For example, if you own 100 shares of a $100 stock and you are worried that the price might drop in the near future, you can buy a put option with a strike price of $95 and an expiration date of six months for $300. This gives you the right to sell 100 shares of the stock for $95 per share at any time before or on the expiration date. If the stock price falls to $80, you can exercise your option and sell 100 shares for $9,500 and buy them back for $8,000, making a profit of $1,200 (minus the premium paid). This offsets your loss from holding the stock and limits your downside risk to $500 ($300 premium plus $200 difference between strike price and purchase price).

Income generation

Options can help you generate income from your existing positions or from idle cash. For example, if you own 100 shares of a $100 stock and you are not expecting any significant price movement in the near future, you can sell a call option with a strike price of $105 and an expiration date of six months for $300. This gives someone else the right to buy 100 shares of your stock for $105 per share at any time before or on the expiration date. You receive $300 as income but agree to sell your shares if they rise above $105. If the stock price stays below $105 until expiration, you keep your shares and the premium. If the stock price rises above $105, you have to sell your shares for $10,500 but still make a profit of $800 ($300 premium plus $500 difference between strike price and purchase price). Alternatively, if you have idle cash in your account and you want to earn some interest on it, you can sell a put option with a strike price of $95 and an expiration date of six months for $300. This gives someone else the right to sell 100 shares of stock to you for $95 per share at any time before or on the expiration date. You receive $300 as income but agree to buy the shares if they fall below $95. If the stock price stays above $95 until expiration, you keep the premium and your cash. If the stock price falls below $95, you have to buy the shares for $9,500 but still make a profit of $200 ($300 premium minus $100 difference between strike price and purchase price).

Speculation

Options can help you profit from your market views or expectations without buying or selling the underlying asset. For example, if you think that the price of a stock will rise in the near future, you can buy a call option with a strike price close to the current price and a short expiration date for a low premium. This gives you the right to buy the stock at a fixed price before or on the expiration date. If the stock price rises above the strike price, you can exercise your option and buy the stock at a lower price than the market price and sell it for a higher price, making a profit. If the stock price stays below the strike price, you can let the option expire worthless and lose only the premium paid. Similarly, if you think that the price of a stock will fall in the near future, you can buy a put option with a strike price close to the current price and a short expiration date for a low premium. This gives you the right to sell the stock at a fixed price before or on the expiration date. If the stock price falls below the strike price, you can exercise your option and sell the stock at a higher price than the market price and buy it back for a lower price, making a profit. If the stock price stays above the strike price, you can let the option expire worthless and lose only the premium paid.

How to Trade Options?

To trade options, you need to open an account with a broker that offers options trading. You also need to have enough funds in your account to cover the margin requirements for your trades. Margin is the amount of money that you need to deposit with your broker as collateral for your trades. The margin requirements vary depending on the type of option, the underlying asset, and the market conditions.

Before you trade options, you need to have a clear idea of your trading objectives, risk tolerance, and market outlook. You also need to understand how options work and how they are priced. You should familiarize yourself with the different types of options, such as calls and puts, American and European, in-the-money and out-of-the-money, and long and short positions. You should also learn about the different options strategies, such as covered calls, protective puts, straddles, strangles, spreads, and collars.

To trade options, you need to follow these steps:

  • Choose an underlying asset that you want to trade options on.
  • Decide whether you want to buy or sell an option contract.
  • Select an option type (call or put) and an expiration date.
  • Pick a strike price that suits your market view and risk-reward profile.
  • Determine how many contracts you want to trade.
  • Place your order with your broker and pay or receive the premium.
  • Monitor your position and adjust it as needed until expiration or closure.
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