February 4, 2014

You’re Insane To Daytrade Options Without Understanding Them

Whoever said they can’t make money in a bear market may have been overlooking options trading. In fact, with call and put options traders are able to make money no matter what the market is doing. Perhaps, this is the reason why so many are flocking to this type of trading in record numbers these days. But with this huge hype around option trading many are diving in too quickly, and obviously getting burnt. On this blog we will go into further details of options and strategies, but first make sure you understand the basics.

What are options?

Options are a unique trading platform in a few different areas. Traders can buy options on most assets just like they normally would. These include options for currencies, stocks, ETFs, and commodities to name a few. Instead of buying these assets outright, the trader buys the right to exercise the price at a future predetermined date. This is referred to as the expiration date of the option. They are typically sold in bundles of 100 shares giving the trader enormous leverage when their hunch is correct. That equates to a healthy profit.
Owning the option, or right, to purchase these shares of assets at a future date will cost the trader a premium. If the trader is wrong about the direction of the asset, then they have the opportunity to cancel out of the option, and will only forfeit their premium to the seller of that option. This is a huge advantage in knowing there is a set amount the trader will lose if they are wrong. In fact, this is part of the reason they are so attractive. There’s also a couple of different ways to make money buying these options in either an up or down market.

What is a call option?

A trader will position a call option on an asset they predict will rise in the near future. When they are right about their assumption they get to exercise the original purchase price for those assets, and keep a nice profit for their effort. Call options are good when the asset is looking to make a bull run.

What is a put option?

A put option works just the opposite of call options. Here, the trader is predicting the asset will lose value by the expiration date on the option. Therefore, if they are correct on this assumption, they can sell their shares at the original cost. This will leave them a profit between that price and the current price, minus any premiums. If their asset should go in the opposite direction then they will return the asset to the market and only lose out on the premium they paid to own the option.

Every trader knows that risk management is critical to having success in any market. This is especially true when selling assets as a bad decision there can wreck an account in a hurry. This is why option trading is quickly gaining popularity. These traders have the ability to know exactly what they stand to lose with a call or put option, but still have the sky as the limit when they do win.

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Max Hansson

Max Hansson is a guest author to the site. Writing about risk, chart strategies and money management. Max is an active day trader of forex, mainly EUR/USD and GBP/USD.