Options trading is a contract that allows investors to purchase and sell stocks at a specific price within the contract period. It is one of the powerful tools investors use in generating wealth over time.
However, just like other investments, options trading comes with its own benefits and risks. Therefore, it is vital for potential traders to understand the inherent risks as well as benefits before choosing to trade before planning the best option trading strategies.
Benefits of Option Trading
Options trading has a lot of benefits that make it helpful for the investors.
1.It is flexible
One of the biggest benefits of options trading is the ability to be flexible and versatile. It gives you many opportunities no matter the market condition. It allows investors to detect how the stock price is moving.
Traders can also predict the price movement of other investments such as foreign currency, commodities, and many more. This gives the trader a large number of leads which helps them make a profitable trading investment.
If you know how to predict changes in the foreign exchange market with industry-specific knowledge, you can trade options in foreign currencies in the forex market.
2.It provides more opportunities
Options trading allows you to create strategies and make decisions that earn you money. Investors only profit from their shares when the stock is high which is not so in options trading. This gives options traders many opportunities to look for trades that are suitable for them and their trading strategies are also unlimited.
Options trading is also available in different areas. This includes foreign currencies, agricultural and energy products, metals, soft commodities, and many more. This provides the traders a wide scope of option trading opportunities.
3.It has a low financial commitment
The money used to buy an options trade is very small when compared to the one for shares outright. Options traders often pay less money to trade. Amazingly, if the trade favours them, they will get the same benefits as the investors who shelled a lot out.
4.It has fewer commissions
The commissions of options trading depend on the type of brokerage you use. There is a lot of competition on online brokerage therefore, they often offer discounts on options trading. This reduces the cost of options trading. Option trading commissions are also very open with no underlying cost and they are lesser when compared to the charges for trading stock.
5.It helps you fix a stock price
An option contract allows investors to strike a price on a specific amount of money for a specific period. Hence, an investor is given the advantage to purchase or sell the stock at the strike price. This can be done at any time before the expiration of the option contract.
Risks of Option Trading
Here are the risks involved in options trading:
1.Option sellers are exposed to more losses
Option sellers can experience losses, unlike the option holder. Their losses are often greater than the price of the contract. This is because an investor is obligated to purchase or sell shares at a particular price before their option contract expires. Even if the price does not favour the investor and there is no limit to how high a stock price can increase. This is applicable when a trader writes a call or put.
2.Traders must meet a certain requirement
Every trader must apply for approval through their broker before they can start an options trading. The broker will ask the trader a series of questions which include investing experience, financial stability, understanding of potential risk, and many more. The broker will then assign the trader a trading level. This trading level will determine the type of options trade a trader can place.
Investors must also keep a minimum of two thousand dollars in their brokerage account before they can trade options. These are the industry terms and conditions that are binding on every investor.
3.Additional cost affects investors to profit and loss
There are different types of options strategies and some often require setting up a margin account. The account stands as a line of credit and collateral in case the trade did not favour the investor. Every brokerage firm has its requirements for opening a margin account and it is often different from one another.
The Bottom Line
Finally, a lot of questions on Option trading might be popping-up in your mind! Remember, Option trading yields better results and lesser risk when you approach it with realistic expectations. When trading an option, it is often advisable to trade with 3-5% of your trading funds. This helps you recover quickly if you encounter any loss.