Options Trading Explained – Free Online Guide to Trading Options

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The Options & Futures Guide

Learn option trading and you can profit from any market condition. Understand how to trade the options market using the wide range of option strategies.

Discover new trading opportunities and the various ways of diversifying your investment portfolio with commodity and financial futures.

To help you along in your path towards understanding the complex world of financial derivatives, we offer a comprehensive futures and options trading education resource that includes detailed tutorials, tips and advice right here at The Options Guide.

Profit graphs are visual representations of the possible outcomes of options strategies. Profit or loss are graphed on the vertical axis while the underlying stock price on expiration date is graphed on the horizontal axis.

Option Basics:
What are Stock Options?

Before you begin trading options, you should know what exactly is a stock option and understand the two basic types of option contracts – puts and calls. Learn how they work and how to trade them for profits. [Read more. ]

Binary Option Basics:
What are Binary Options and How to Trade Them

Binary option trading is quickly gaining popularity since their introduction in 2008. Check out our complete guide to trading binary options. [Read more. ]

Beginner Strategy:
Covered Calls

The covered call is a popular option trading strategy that enables a stockholder to earn additional income by selling calls against a holding of his stock. [Read more. ]

Stock Option Advice:
Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read more. ]

Stock Option Trading Basics:
Why Invest with Options?

For the short to medium term investor, stock option investing provide an additional suite of investment options to let him make better use of his investment capital. [Read more. ]

Advanced Concepts:
Understanding Option Greeks

When trading options, you will come across the use of certain greek alphabets such as delta or gamma when describing risks associated with various options positions. They are known as “the greeks”. [Read more. ]

Option Trading Advice:
How a Low Commission Broker Can Increase Option Spreads Profits by 50% or more

Many options traders tend to overlook the effects of commission charges on their overall profit or loss. It’s easy to forget about the lowly $15 commission fee when every profitable trade nets you $500 or more. Heck, it’s only 3% right. [Read more. ]

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Stock Options Advice:
Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read more. ]

Advanced Concepts:
Put Call Ratio – What It Is and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read more. ]

Advanced Concepts:
Futures Options Trading

Another way to play the futures market is via options on futures. Using options to trade futures offer additional leverage and open up more trading opportunities for the seasoned trader. [Read more. ]

Stock Option Advice:
Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read more. ]

Stock Options Tutorial:
Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read more. ]

Stock Options Advice:
Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read more. ]

Stock Option Tutorial:
Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read more. ]

Options Trading Strategies: A Guide for Beginners

Options are conditional derivative contracts that allow buyers of the contracts (option holders) to buy or sell a security at a chosen price. Option buyers are charged an amount called a “premium” by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthless, thus ensuring the losses are not higher than the premium. In contrast, option sellers (option writers) assume greater risk than the option buyers, which is why they demand this premium.

Options are divided into “call” and “put” options. With a call option, the buyer of the contract purchases the right to buy the underlying asset in the future at a predetermined price, called exercise price or strike price. With a put option, the buyer acquires the right to sell the underlying asset in the future at the predetermined price.

Why Trade Options Rather Than a Direct Asset?

There are some advantages to trading options. The Chicago Board of Options Exchange (CBOE) is the largest such exchange in the world, offering options on a wide variety of single stocks, ETFs and indexes. Traders can construct option strategies ranging from buying or selling a single option to very complex ones that involve multiple simultaneous option positions.

The following are basic option strategies for beginners.

Buying Calls (Long Call)

This is the preferred strategy for traders who:

  • Are “bullish” or confident on a particular stock, ETF or index and want to limit risk
  • Want to utilize leverage to take advantage of rising prices

Options are leveraged instruments, i.e., they allow traders to amplify the benefit by risking smaller amounts than would otherwise be required if trading the underlying asset itself. A standard option contract on a stock controls 100 shares of the underlying security.

Suppose a trader wants to invest $5,000 in Apple (AAPL), trading around $165 per share. With this amount, he or she can purchase 30 shares for $4,950. Suppose then that the price of the stock increases by 10% to $181.50 over the next month. Ignoring any brokerage, commission or transaction fees, the trader’s portfolio will rise to $5,445, leaving the trader with a net dollar return of $495, or 10% on the capital invested.

Now, let’s say a call option on the stock with a strike price of $165 that expires about a month from now costs $5.50 per share or $550 per contract. Given the trader’s available investment budget, he or she can buy nine options for a cost of $4,950. Because the option contract controls 100 shares, the trader is effectively making a deal on 900 shares. If the stock price increases 10% to $181.50 at expiration, the option will expire in the money and be worth $16.50 per share ($181.50-$165 strike), or $14,850 on 900 shares. That’s a net dollar return of $9,990, or 200% on the capital invested, a much larger return compared to trading the underlying asset directly. (For related reading, see “Should an Investor Hold or Exercise an Option?”)

Risk/Reward: The trader’s potential loss from a long call is limited to the premium paid. Potential profit is unlimited, as the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go.

The Nasdaq Options Trading Guide

Equity options today are hailed as one of the most successful financial products to be introduced in modern times.

E quity options today are hailed as one of the most successful financial products to be introduced in modern times. Options have proven to be superior and prudent investment tools offering you, the investor, flexibility, diversification and control in protecting your portfolio or in generating additional investment income. We hope you’ll find this to be a helpful guide for learning how to trade options.

Understanding Options

Options are financial instruments that can be used effectively under almost every market condition and for almost every investment goal. Among a few of the many ways, options can help you:

  • Protect your investments against a decline in market prices
  • Increase your income on current or new investments
  • Buy an equity at a lower price
  • Benefit from an equity price’s rise or fall without owning the equity or selling it outright.

Benefits of Trading Options:

Orderly, Efficient and Liquid Markets

Standardized option contracts allow for orderly, efficient and liquid option markets.

Flexibility

Options are an extremely versatile investment tool. Because of their unique risk/reward structure, options can be used in many combinations with other option contracts and/or other financial instruments to seek profits or protection.

Leverage

An equity option allows investors to fix the price for a specific period of time at which an investor can purchase or sell 100 shares of an equity for a premium (price), which is only a percentage of what one would pay to own the equity outright. This allows option investors to leverage their investment power while increasing their potential reward from an equity’s price movements.

Limited Risk for Buyer

Unlike other investments where the risks may have no boundaries, options trading offers a defined risk to buyers. An option buyer absolutely cannot lose more than the price of the option, the premium. Because the right to buy or sell the underlying security at a specific price expires on a given date, the option will expire worthless if the conditions for profitable exercise or sale of the option contract are not met by the expiration date. An uncovered option seller (sometimes referred to as the uncovered writer of an option), on the other hand, may face unlimited risk.

This options trading guide provides an overview of characteristics of equity options and how these investments work in the following segments:

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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