Options Trading - Some Quick Facts

Options trading are one of the most complex and misunderstood financial trading instruments amongst a host of others including bonds, securities and mutual funds. Simply put, options trading are a contractual means of conveying rights to buy or sell a particular security at a specified price on or before a predetermined date.  The two kinds of options are called ‘Calls’ and ‘Puts’.

Call Options are contractual rights (as against obligations) to buy shares of an underlying security at a specific price on or before a given expiry date. Put Options are contractual rights to sell shares in the same way.

So if a trader were expecting a security to do well, he would purchase a call option or what is also called a long position. In doing so, he would have the chance to make a profit on the higher price that the security was expected to jump to. On the other hand, if the security was expected to decline, he would purchase a put or what is called a short position expecting to make a return by being able to sell at a much higher price than the market.

Depending on the position you decide to take, you can be:

1. A buyer of calls
2. A buyer of puts
3. A seller of calls
4. A seller of puts

The first two categories or the buyers or
options are called holders and the other
two are called writers. The important
difference between the two is that holders
exercise choice while the seller does not.
The seller is obligated to sell at the price
agreed upon while the buyer may or may
not choose to buy.

Your options trading strategy can be tailored
to suit your risk taking and financial ability.
The biggest advantage of Options Trading is
that it allows you to bet on the price
movements in the market without committing
a large number of funds. So in effect, you
buy the option of buying or selling instead of
actually doing so immediately. Of course,
if you do not go through with your transaction, you lose the amount you purchased the option at.

There are three common uses of this strategy - Hedging, Speculating and Employee Stock Options. Speculating is the most popular and all has the highest risk. The potential to make an upside without an upfront monetary commitment is what makes options so attractive. Hedging is like buying an insurance policy in the form of an option so that even if the price were to decline, your security price is insured. Third is ESOP or Employee Stock Option Plans which is not really commercial trading but follows the same principle i.e. the employee has the option but not necessarily the obligation to purchase company stock.

Given the flexibility that options trading provide, it does not come without inherent risks so it is important to read all associate terms and conditions and not use anything other than risk capital when engaging in options trading.