Options alerts can be an impressive way to make money from the stock market, but it can also confuse beginners. So, if you are a beginner, this guide will break down the basics of options trading and give you the information you need to get started. And make your friends jealous with all the money you can make.
What are the options?
Even if you are a beginner, you must know what an option is. ‘An option is a contract that gives the buyer the right, but not the obligation, to buy or sell a particular asset (such as a stock) at a specific price within a specific time frame’ –Google.
We will learn about two types of options: call and put options. Let’s look at what they are:
Call options
A call option gives the buyer the right to buy the underlying asset at a specific price (strike price) at a certain time. The call option buyer believes that the underlying asset’s price will increase and wants to profit from it.
For example, you buy a call option for Yahoo stock with a strike price of $50 and an expiration date of one month from now. If the price of that stock goes up to $60 during that month, you can exercise your option and buy the stock for $50, then sell it for $60, making a profit of $10 per share. You get an options alert every time the prices go up.
Put options
A put option gives the buyer the right to sell the underlying asset at a specific price (this is also called the strike price) at a certain time. The put option buyer believes that the underlying asset’s price will go down and wants to profit from that decrease.
For example, you buy a put option for Yahoo stock with a strike price of $50 and an expiration date of one month from now. If the price of Yahoo stock drops to $40 during that month, you can exercise your option and sell the stock for $50, then buy it back for $40, making a profit of $10 per share.
How do the options work?
They are traded on exchanges, just like stocks. When you decide to buy an option, you will pay a premium to the seller for it. The premium is the price you pay for the right to buy or sell the assets at the strike price or whichever price you choose to sell them on.
Options have expiration dates, meaning they can only be exercised within a certain time frame. Once the option expires, it is worthless. So you must be very careful regarding the dates otherwise you can face loss.
They also have strike prices, which are the prices at which the underlying asset can be bought or sold. In the examples above, the strike price for both the call option and the put option was $50, and you can call this price its strike price.
Like stocks, they can be bought or sold as this is how you earn money. If you buy it, you are called ‘long the option’. If you sell it, you are called ‘short the option.’
Options trading strategies
Now, let’s look at what strategies you can use to earn some money with options. There are many strategies, but we will discuss the best ones.
Covered call
A covered call is a strategy in which you own shares of a stock and sell call options against those shares. The idea behind using this strategy is to earn money from the premiums you receive for selling the options while still benefiting from any increase in the stock price. This way, you can benefit in 2 ways. The first is from selling the options, and the second is from an increase in stock price.
Straddle
A straddle is a strategy in which you buy both options: call and put options for one basic asset with the same strike price and expiration date. This strategy aims to profit from any significant move in the underlying asset, regardless of whether it goes up or down. So, no matter what happens, you will get the benefit.
Iron condor
An iron condor is a strategy that sells both the put and call option for similar assets with a different strike price and expiration date. This strategy aims to profit from a range-bound market where the underlying asset stays within a certain price range.
