The world of investing is very tricky as it is rewarding. And there are a lot of assets/securities you can invest your money in (futures, stocks, bonds, options, and many others).
While most investors like to trade mutual funds because of its simplicity, braver investors try out stocks and bonds. However, Options trading can be a better way to increase your income if you are doing it right.
What is Options Investing?
Options investing are backed by contracts that grant you rights (not obligation) to buy or sell an asset or stocks at a future date for a particular price.
Let’s view it this way, I want to buy 100 000 shares in a company ABC stock for $10 per share, but I can’t somehow finance the cost of the total shares ($1 000 000) either from lack of funds, or cold feet or whatever. I can opt for an Options contract with the company where I will purchase the OPTION to buy the shares for $10 000. This way, I am purchasing an Option instead of the stock, and no matter what the stock does, the contract lasts for a month.
So, if within a month, the company ABC sees a massive positive turnaround, and the stocks climb from $10 to $100 per share, I can exercise my Option to buy. And purchase $10 000 000 worth of stock for $1 000 000. Therefore, you make a profit of $(10 000 000- 1 000 000) = $99 990 000 (should you decide to sell).
On the downside, if the Stock drops say from $10 to $1, I can choose to let your option expire (since it will be worthless), and I make a loss of only $10 000 that I paid for the Option.
Options are securities and belong to the derivatives group. For derivatives, their prices are dependent on real assets. Examples of derivatives are puts, calls, futures, forwards, swaps.
Call Options
A call option gives the holder the right to buy a stock at a fixed future price. For example, an investor might feel a stock will do well in the future but doesn’t want to buy now. The investor will pay a Premium to tie that stock. So, if the stock does well, they can buy the share at the fixed price, and if it doesn’t, he can forfeit his call Option.
Put Option
Opposite of the call option, the Put option gives the holder the right to sell his stock at a future fixed price.
A shareholder can decide that his $5000 stock might be worthless in the future and be unwilling to lose more than 10 % of the value; he can purchase a put option that gives him the right to sell for $4500 no matter the market crash. The investor pays a premium so that even if the shares drop to $200 per share, he still sells for $4500 and loses just 10%.
Expiration Date
The expiration date is the specific date on which the trader specifies the stock to rise or fall. It helps traders to price the value of the put and call.
Strike Price
It is the price that an investor uses to determine if he should exercise an option. If a trader bets on 3M stocks to rise above $170 by mid-February, the investor will buy a February $170 call.
Premium
It is the money paid for an option. You get it by multiplying the price of the call by the number of contracts you purchase, and then by 100. If a trader purchase 6 Feb $170 calls at $1, it will cost him $600
Intrinsic value
It means that the underlying asset price is above the call/put strike price.
Extrinsic value
It means the underlying asset price is below the call/put strike price. The value paid is based on time and volatility.
Seller
Any individual or entity that engages in offering financial securities (stocks, options, commodities, currencies, and co.) is a seller.
At the money
Means an even point between underlying and strike price
Covered Call
A covered call is a transaction in which the investor selling call options own an equivalent amount of the underlying security. To execute, the investor holding a long position in an asset can then write call-options on the asset. He then receives income in Premiums.
