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Beginning day trading is a daunting task, and it might feel difficult and hopeless before one has been able to build proper strategies and found the most efficient ways to trade. In this report, we will discuss the strategy of options trading and how this cost-efficient strategy can increase success rates.
What are the Options?
Let’s start with the basics: what is options and how do you trade options? In the most fundamental description, daytrading.com describes it as a “straightforward financial derivative”. Put plainly, options trading is a form of trading where you have the right to sell or buy an asset within a pre-determined date, also known as the “exercising date”. The term “exercising” means buying or selling the asset.
The assets that you can exercise include stock options, ETF options, futures options, etc. These traditional assets are typically referred to as “vanilla options”. The options trader has an obligation to exercise the asset before the expiration date.
How do I trade options?
Similarly, to trading futures, the trader needs to provide an options contract. The contract needs to include a range of basic information, including.
- The type of option (call/buy or put/sell)
- The underlying security
- The strike price
- The unit of trade (the number of shares)
- The expiration date
When it comes to options, the contract will assume that the number of shares of the underlying stock is 100. This will be the case unless the trade is focused on stock splits or mergers.
Exercising the option
Exercising the option means to put (sell) or call (buy) the option. If you are trading in America, this can be done before the expiry date, whereas European trades can only be redeemed on the expiration date. Options can be bought on stocks the buyer already owns or other underlying assets.
Benefits from trading options
Cost-efficient
The first and most obvious benefit of trading options is its low-cost efficiency. As options do not require the buyer to purchase the actual stock, it is a lot cheaper but the trader can still reap the same rewards as a regular stock. Therefore, buyers can receive a much larger percentual reward by spending less in the first place.
Flexible and diverse
Trading in options is a lot more flexible as it can widen possible trades. For example, the fact that you can combine options with stocks or futures allows for a larger and more diverse range within the trade. The combination also allows for risk-reduction strategies, as they become less dependent on one sector of day trading or economically vulnerable areas.
Risks of options trading
There are of course risks one should be aware of while engaging in options trading. One of these is that the bid-ask spread becomes much wider, which might consequently produce fewer profits. Another risk to be aware of is that of price movement reductions. In other words, the price movement and the time movement might be contrary to one another, resulting in price drops. However, as you have spent less entering the trade, your losses will likely be smaller than if you engaged in traditional stock or forex trading.
