For many new traders, options trading is overwhelming for most and confusing to the rest. However, it is a fairly straightforward process as long as you are able to understand some key aspects.

If you look at the average investor profile, you will likely see several different asset classes. Some of these asset classes may be mutual funds, ETFs or even stocks and bonds.

Options are another type of asset class, and when investors use them correctly, options can offer as many advantages that EFTs, stocks, and bonds are not able to on their own.

Understanding Options

Options are simply contracts, and these contracts give the bearer of the contract the right to buy or sell an amount of an underlying asset at a price that has been predetermined. The bearer must buy or sell the amount at or before it expires. Investors can choose to purchase options with their brokerage investment accounts just like they would any other asset.

These types of assets are very powerful because they have the ability to greatly improve an investor’s portfolio, and they are able to do this in several ways:

• Protection
• Additional income
• Leverage

There are some situations that occur when an investor would be able to utilize an option scenario to help them get closer to their goal. For example, options can often be used against a decreasing stock market in order to restrict downside losses. In this type of scenario, the options would act as a hedge.

Options can also be used for speculative trading such as betting on which direction a stock will go.

Options Are Great For Independent Investors

Many options traders are typically self-directed investors. This means that they do not work with a financial advisor directly. As an independent investor, they are in complete control of the decisions that are made during trading. However, that does not mean that they are alone when they are trading.

There are lots of online communities that independent option traders can join so they can discuss topics of interest such as strategies for option trading and the current outlook of the market.

New Investors Usually Start With Stock Options

Stock options are options that are based on equities. This is usually the first introduction to investors who are new to options trading. These options are on the NYSE and other exchanges and they are listed as quotes. Investors should make sure that they thoroughly understand the ins and outs of stock options quotes before they make their first investment. The two things that you must understand are the expiration date and the cost.

What Are The Different Options?

There are only two types of traditional options contracts. One is a put and the other is a call.

A ‘put’ option allows the investor the right to sell shares of certain security within a certain time frame and for a certain amount.

A ‘call’ option allows the investor to purchase shares of a certain security at a specific price and within a certain time frame.

It is important to keep in mind that for both of these options contracts, the investor is under no obligation to buy or sell.

Derivatives

Options are just one piece of a much bigger securities group that is known as derivatives. The price of a derivative is dependent on how much something else costs.

For example, ketchup is a derivative made from tomatoes and lemonade is a derivative of lemons. Along the same lines, stock options are a derivative of a stock.

Options are then derivatives of financial securities. This means that their value is depending on another asset’s price. Examples of other derivatives include:

– Swaps
– Futures
– Calls
– Puts
– Forwards
– Securities (backed by mortgages)

Options Trading Is About Risk

If you enjoy probability and statistics, then you will likely enjoy volatility and options trading. Investors only really need to focus on two types of volatility, and they are implied volatility and historical volatility.

Implied volatility is trading based on what the market is currently ‘implying’ how volatile the stock will be later and over the option contract’s life.

Historical volatility is representative of the past markers and how much the price of the stock fluctuated daily over a period of one year.

Just as with other investors, it is important the option traders understand their financial goals. The way you think about and handle your money will directly impact your success with options trading.