Perhaps among the most complicated and possibly the riskiest type of trading is option trading. Many seasoned traders realize that option trading does not suit all traders. It requires its own type of people, usually the risk takers. And the trade itself requires skills and knowledge unique only to people who won’t fold under extreme risks. Most experts recommend this kind of trading only to those folks who have enough risk capital as it carries with it large risks.
By default, it is also speculative. So if you are a person who doesnt like to speculate too much, you should find another kind of security which will work best for you. However, rejecting the idea of entering this trade right now is as risky as not knowing anything about it. It carries with it risks, thats true,for sure, but it is also a highly profitable venture. You might as well try to understand something on it such that you could decide whether to go for options trading or not.
While it is inherently risky, option trading also puts forth advantages that may not be had with different types of trades. Some of its wonderful advantages is the flexibility it lends its investors. Each lender has the option to trade at a specific price within a specific period.
It is also, when comparing the two, a more advantageous type of trade due to its high leverage it offers. Depending on the location, each option may cover a few underlying assets. In the United States, for instance, each option may represent for 100 underlying assets. Thus, this principle lends the holder the capacity to gain from several assets within a single option.
So tell me about an option?
An option is a kind of security, generally closely comparable to bonds and stocks. It is, on its own, a binding contract, that is monitored by and through strict terms and conditions. In gist, options are contracts that owners could buy or sell at a certain price before or on a certain date. An option is typically an additional price tag to a specific asset or item because it is a reservation for the purchase or sale of a specific asset.
Options are also occasionally called derivatives. This is due to the fact that the value of an option is derived from the value of the underlying asset.
To better understand this topic, lets look at the example below:
Say you have considered buying a real estate property which is worth several hundred thousand dollars. But, when you originally negotiated with the owner, you did not have enough money to purchase the property on the spot. So you made a deal with the owner to pay an extra $5,000 to keep the deal for you for the length of two months. The extra money you shelled out is called the options. In case you dont want to continue with the sale, the owner of the real estate is not allowed to force you to purchase the property nor can the law impose the sale on you. But, you would still have to shell out the price of the option.
In conclusion, when thinking about purchasing a property with an enclosed option, you will have the right to continue with the sale or to discontinue the sale. You are not mandated to do either of the two. But be aware, you could lose 100% of your total investment in options trading which is the value of the option itself.