Some investors are happy with capital growth on their portfolios when trading stock markets, while some are looking for higher returns. There exists an option where there is still potential to make a lot of money, yet with lower risk than buying shares. Options trading can be an appealing method of making money in the financial markets, yet many people fail to understand even the basics of this complex transaction.

Nowadays, many brokers will allow you to sign up for an account and trade options, even without qualifications or financial investments. You will, therefore, only need the required funds to cover the initial margin requirements set out by your broker before you can begin trading.

Greater returns are possible with options trading because of the increased risk involved - therefore, for many investors, this is very appealing. To learn more about options trading, follow online guides explaining how it works and what factors you should consider when opening up an account.

What You Need to Know About Trading with Options

If you want to take advantage of the fact that options can make you a lot of money, but only if the market goes in the directions you expect, then there are certain things that you need to know before making such bets. It is impossible to predict how an option will perform, and therefore you should understand all possible outcomes even when using highly educated forecasts.

Many people lose out simply because they do not understand precisely what they are doing or because a broker has made a mistake. Here is some key terminology so you can understand exactly what we're talking about:

Strike Price - This is the price where the underlying security for your option contract trades should be at while being exercised by your option contract.
Expiration Date - This is the date where your option contract expires and matures and thus can be exercised by you or your counterparty (if assigned)
Underlying Security - This is the security subject to the terms of your option contract. It could be stock options, index options, put options, call options, futures contracts etc.
Exercise - The process where you choose to buy or sell an underlying security at a strike price specified in your options contract. Usually, this will happen around expiry time which occurs on the expiration date unless otherwise extended.
Assignment - The notification sent by exchange or broker to both parties involved with an open option contract notifying them of the exercise
Option Premium - This is what you need to pay to make a formal contract with another party for a specified option
Exotic Options - A type of options contract that is more complex and typically comes with a higher premium
Cash-Settled Contracts - Instruments where cash is paid out instead of shares.
American Style Options - These are options contracts giving their owners the right, but not the obligation, to exercise at any time during its lifetime as long as it remains an open contract.
European Style Options -These option contracts restrict their owners from exercising them until they expire. The expiry process for these types usually takes place on the third Friday of the expiration month.

What is Margin?

When trading options, one needs only to have access to the initial margin requirement set by your broker. These requirements vary depending on what type of investor you are and how much experience you have. An investor might need up to 50% of the value of their portfolio available as collateral, whereas experienced investors may be able to trade with just 10%. A trader might also need additional funds available if prices suddenly change, and they would have to provide more collateral. In some cases, investors need to maintain a certain standing for their deposit to be accepted by the broker.

Although trading options is not something you should jump into without understanding what it entails, once you have picked up enough knowledge on how it works and what factors affect your decisions, there is a lot of money that can be made by exploiting the full potential these instruments offer.

By Russell Fenton

© 2021 Copyright Russell Fenton - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods

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