Everything you need to know about options trading before making your first trade

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The current bear market has forced many traders to look for other opportunities like options trading, to hedge against the price declines that many spot traders are seeing today. The last time we saw this level of activity in the options market today was in 2021, when 9.92 billion contracts were traded, a record high, according to data from The Options Clearing Corporation ( OCC).

Although you may have heard of the exponential amount of money you can make trading options, it is important that you know exactly what you are getting into and your money before you begin this trading journey.

Options trading is how investors can speculate and predict the future direction of the global asset class they are trading, such as stocks or cryptocurrencies. Options contracts give you the choice, but not the obligation, to buy or sell an underlying asset at a specified price on a specified date.

Stephen Callahan, Vice President of Client Services at Firstrade, explained, “Options trading can be a great way to increase your income, limit your risk, and protect yourself from market fluctuations at the same time.” How? Here’s what you need to know.

Options Trading Fundamentals

As mentioned earlier, an option is a contract giving the investor the right (or the option) but not the obligation to buy or sell a specific class of asset, at a specified price (also known as the “price of ‘exercise’) for a fixed period of time, ranging from a few days to several years. When this specified time expires and the option expires, it no longer has any value and no longer exists.

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Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research, gave a more detailed description of what options trading really is by stating, “Unlike stocks, an option does not represent ownership of the underlying company. Because it is a contract, it represents potential ownership, but it must be exercised for that to happen.

It is important to know that there are two types of options which are; calls and bets. Call options give the holder (buyer) the right to buy a specified number of an asset class at the strike price, at any time until the contract expires. Put options give the holder the right to sell a specified number of shares of an asset class, at the strike price, at any time until the contract expires.

When you trade options, you have to pay a premium up front, which then gives you the option of buying an asset class, buying options or selling the asset class, or selling options, at the designated strike price prior to the expiration date.

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This means that a lower strike price has more intrinsic value for call options since the options contract allows you to buy the asset at a lower price than it is currently trading. If the asset price remains, your call options are in the money and you can buy the stock at a discount.

Conversely, a higher strike price has more intrinsic value for put options because the contract allows you to sell the stock at a higher price than it is currently trading at. Your options are in-the-money if the stock stays at its current price, but you have the right to sell it at a higher strike price.

It is important to note that a stock position can often be held for a very long period of time, all options eventually expire. As they approach their expiration date, options typically lose value and may end up being worthless. Market volatility near expiration can also increase an investor’s risk that an option will be worthless when it expires.

As a guide, choosing a call or put option depends on what you want to achieve as an options trader. It’s never a good idea to just choose an option for your portfolio without doing your research and deciding whether or not it fits your investment goals.

Why options are so popular today

In crypto, for example, a number of crypto exchanges have noted an increase in trading volume after hitting lows earlier this year. Options strategies have figured prominently among institutional investors and even miners as they try to weather the usual crypto volatility and a downturn that could last for months, or even longer, despite recent macro signs. promising.

More recently, traders have been using the crypto options market to bet on Ether (ETH) and hedge positions ahead of the highly anticipated Ethereum blockchain merger. Panama-based derivatives platform Deribit, which is one of the world’s largest exchanges for crypto options trading volume, said in a report that Ether options trading is booming ahead of the merger. .

Due to the fact that options can offer very high returns and do so in a very short period of time, using the power of leverage to turn a relatively small sum of money into a huge sum is the main why we see this particular investment vehicle has become very popular, despite the high level of volatility in the options market, because options are generally risky, however, some options strategies can be relatively low risk and can even improve your returns as an equity investor.

Should you trade options?

As mentioned earlier, options trading is known to be quite risky, especially due to its complexity to understand. This is why it is crucial that investors know how options work before committing. Investing your money in something you don’t understand is never a smart financial decision.

The risk you take as an options investor ultimately depends on your role in the contract (which side you are on) and your strategy, as there are several strategies you can implement using different combinations options. However, we ultimately advise that this type of asset is too risky and small retail traders should not trade this investment vehicle, expecting to lose all their funds.

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