If you want to invest your money with a low-risk profile, option trading would be an ideal bet for you. With real-time option trade alerts, you can withdraw at any moment and sell/buy shares in future with ease. However, that’s not all. If you’re new to option trading, here are five essential things you must know before investing your money into it.
1. Types of option trading
When you own an option, you become the owner of a contract that gives you the right to buy or sell an asset at a particular price for a specific timeframe. There are two types of options contracts- Call and Put.
Call options contracts give you the right to purchase 100 shares of a particular security at a specific price within a given period.
Put options contracts give you the right to sell 100 shares of a particular security at a specific price at a given timeline.
2. OTM options are not exact money makers
People often buy out-of-the-money call options hoping they will rise in the future, leading to a decent profit. However, this could be risky since most options expire worthlessly. For example, Let’s assume you purchase a stock with the current price of $40 at a call option with a $45 strike price. After two months, it expires at $0.50. Even if the stock rises to $55 after a while, it will only be a $10 difference. Therefore, buying OTM calls may not be the right decision for you, especially if you are a beginner.
3. Learn about Implied Volatility
Implied Volatility (IV) states whether the price of the option is going up or down. It is influenced by the supply and demand of an Option and the share price’s direction. Implied volatility rises with the rise of expectations and demand. The rise of the IV means the option price will go higher.
For instance, short-dated options are less influenced to implied volatile compared to long-dated options. This is because options lose their value when closer to expiration.
The best way to analyze implied volatility is to integrate Implied Volatility options in your option trade alerts.
4. Monitor the time decay
The Time Decay refers to the value reduction of an option when it approaches the expiration date.
Option price = time premium + intrinsic value
Each option comes with a specific amount of time premium. Meaning, the price you pay for the option comprises the option’s intrinsic value plus the time premium.
The time premium keeps declining as an option reaches its expiration. Therefore, in most cases, traders use multileg strategies to buy in-the-money Options at a lower time premium and sell out-of-the-money Options to balance the time decay.
5. Options are meant for hedging
Options are not trading products, unlike equities and futures. Hedging is the primary reason behind the creation of Options. If you have a stock at hand, you can protect it from downside risk by purchasing a put option. Likewise, you can reduce your holding cost by selling higher call options about to expire at worthless rates.
If you’re all set to start investment into option trading, start with small risks. Once you get your ways around minting profits with option trade alerts, take calculated risks to mint more profits.