Option Trading

Details

Category: Trading Type

Option trading can be confusing because they add another level of complexity to investing. They also have a unique terminology that must be mastered to understand what a particular option trading contract represents. Perhaps the most common misunderstanding for those new to option trading, is the idea that no shares of the underlying security change hands when an option trading is written or purchased; an option trading is nothing more than a contract between two parties.

Option trading are a type of financial security, just like stocks, bonds and mutual funds, and can be bought and sold just as easily as one buys and sells stocks. Option trading are known as derivative investments because their value is derived from the value of the underlying stock (when buying or selling option tracings on stocks) or commodity (when buying or selling option trading on commodity futures). Generally, option trading is used as a tool to make more leveraged investments in common securities. Because they are less expensive than the underlying asset, relative percent return that can be achieved through option trading is significantly higher than on the underlying asset alone. The graph below shows just that.

In finance, an option trading is a derivative financial instrument that establishes a contract between two parties concerning the buying or selling of an asset at a reference price. The price of an option trading derives from the difference between the reference price and the value of the underlying asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiration of the option trading. Other types of option trading exist, and option trading can in principle be created for any type of valuable asset.

An option trading which conveys the right to buy something is called a call; an option trading which conveys the right to sell is called a put. The reference price at which the underlying may be traded is called the strike price or exercise price. The process of activating an option trading and thereby trading the underlying at the agreed-upon price is referred to as exercising it. Most option trading has an expiration date. If the option trading is not exercised by the expiration date, it becomes void and worthless. In return for granting the option trading, called writing the option trading, the originator of the option trading collects a payment, the premium, from the buyer. The writer of an option trading must make good on delivering (or receiving) the underlying asset or its cash equivalent, if the option trading is exercised.