You Can Get Bigger Returns With Stock Options While Limiting Your Risks…
Investing In Stocks Is More Long Term
Just like futures contracts and stocks, options are securities which are subject to binding agreements. Options trading give an investor the right to sell or buy an underlying asset or security. Such as investor is not obligated to do so as long as he or she follows the contract’s rules. This article looks at the major differences between stocks and options.
Options happen to be derivatives. A derivative is a financial tool that gets its value from the underlying time and security as opposed to its own intrinsic value. For instance, IBM’s stock options are influenced directly by the price of the company’s stock.
One of the reasons why options are cheap is because they are time-limited. A short or long position that involves stock can be held indefinitely, while an option position can only be held until its expiry date. When someone buys an option, he or she can choose from a number of expiry dates. The longer an investor holds on to an option, the more expensive it becomes. This is something that affects options trading profits. Another vital aspect of the time limitation is that in case the stock price does not change, an option’s value reduces with time. This is among the risks of owning an option.
Investors looking for stocks to invest in should know that as their price changes, the option price also changes. However, this is by a lesser amount. There is a reference price that influences how closely the option price change matches the stock price change. This reference price is referred to as the strike price and is usually designated in the options contract.
Rather than investing in stocks, an investor may decide to buy an option by choosing from several options. There are terminologies used by traders for describing the relative relationship between an option’s strike price and the stock price. If the strike price of either a put or a call is almost similar to the stock price, the option is at the money. If it is above the stock price, the option is out of the money. If it is below the strike price, it is in the money.
In the case of an at-the-money option, the option’s price changes by roughly 50% of the stock price’s amount of change. For out of money option, the option’s price changes by less than 50% of the stock price change. An in-the-money option’s price moves by over 50% of the stock price change.
When someone buys an option, his or her maximum risk is limited to the option’s original cost. The worst probable outcome is that they hold the option until it expires. By that time, it will have become worthless due to the failure of the stock price to move in manner that is beneficial. A major risk in trading options is that an individual invests heavily by buying several contracts and allowing them to expire and become worthless. This represents a loss of 100% on a significant investment. However, one can always sell the options before expiration and recover some of the original cost.
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