Wednesday, May 22nd, 2019

Trading Options

 

Trading options can represent the best as well as the worst of trading. Trading options can allow the investor to make great profits. It can also lead to disastrous results if he or she doesn’t stay with a proven trading plan. No matter what you know, it is always good to have an introduction to trading options.

First a Definition

Options are legal agreements that give their buyers the right, not the obligation, to sell or purchase the underlying assets at a future date. Whether it is in stock options trading or in trading commodities like corn futures, trading options allows the investor to invest trading capital using a variety of strategies. Traders use call options to reserve the right to buy and use put options to reserve the right to sell.

Hedging and Speculation

While other reasons also exist, the two common reasons for trading options are hedging and speculation. Each has a different philosophy as well as techniques for trading. Before attempting either strategy, it is important to understand the differences between them and incorporate the one that makes sense to you.

Hedging

When you purchase stocks or commodities in an attempt to offset a potential downturn, you are hedging. Hedging is like an insurance policy that protects the investor in the event of a negative price movement. By purchasing put options, you are able to reduce the potential downside of your trading while still receiving the full benefits of investing. The beauty of this is that you limited your risk while preserving your profit potential.

Hedging can be done by investing in stable stocks or commodities to offset any potential losses in case of unexpected market moves. In addition, it can be done as a separate investment on an existing commodity investment; by having a second, opposing investment, it is possible to minimize any potential losses in the first position. An example is to use a long straddle strategy in which a trader purchases both a call and a put on the same equity with the same expiration date.

Speculation

When trading options, speculation is the opposite of hedging. While hedging is a defensive investing strategy, speculation is purely an offensive one. Speculation can be looked at as a bet by the investor on the price movement. The interesting part of trading in this manner is that not only can you make money when the market goes up, but you can profit when it goes down or even sideways. To be successful you must correctly analyze the direction of the movement as well as the amount it will move. If one does not expect the market to move one can often make money by selling calls and or puts on an equity. If one expects price movement one purchases calls or puts depending on the direction in which one expects the equity to move. Trading options provides leverage in that one need not, for example, buy a stock but need merely buy a call contract. If the price of the stock goes up so does the value of the option contract. The profit is the same but the percent return on investment can be substantially greater when trading options.

Skill Set, Knowledge Base and Practice

As with any type of investing, it is important to follow the steps for successful trading, including establishing a trading system and performing technical analysis. It is always important to audit your trading results and get fresh advice when needed.

Understanding Options

Trading options is an excellent way to accumulate wealth. It is important to understand the approach that you wish to take and follow that method, whether you are hedging or speculating. By understanding about trading options you will be able to implement your plans and confidently follow them, giving you the opportunity to be a successful trader in the futures market.

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