If you are a day trader, you already know that money can be made on the fluctuations of the stock market. When all goes as planned, day traders make money by buying stocks at a low price and reselling them when the price is higher. However, this strategy involves a large amount of upfront cash, or in some situations, the risk of trading on margin.
If you hope to make money in the stock market but don’t want to risk large amounts of cash or credit, you may want to consider trading options. By buying and selling options instead of actual stock shares, you can leverage your money for a higher return with less risk to your financial security.
How Do Options Work?
Options are contracts that give the owner the right to buy or sell an asset at a set price between the time of purchase and the predetermined exercise date. If the price of the asset moves in the direction that the owner had hoped, the option will be exercised at the predetermined price. But if the movement is in the opposite direction, the options contract expires, and nothing is exercised.
If you are the person who sold the contract, you are legally obliged to meet the terms of the contract. In other words, if you agreed to sell stock at a set price on a specific day, and the buyer wants to exercise the option, you are obliged to follow through.
What Type of Options Exist?
The two categories of options are calls and puts. A call option allows the contract owner to purchase a block of stocks at a specified price. Conversely, a put option allows the contract owner to sell stock shares at a specified price.
In either case, the option contract includes numerous specifications:
- Type of option
- Underlying asset
- Price at which the option can be exercised
- Number of shares covered by the contract
- The last date on which the option can be exercised
What Are Some Effective Strategies?
One popular options trading strategy is to leverage a small amount of money with the potential for big gains. It’s much cheaper to purchase options for shares than it is to purchase the actual shares. As a result, you can control large numbers of shares with small capital investments.
For example, if you believe that a company’s share price may spike following its upcoming earnings report, you can buy call options for the number of shares you are interested in. If the price skyrockets, as planned, you will be able to buy the shares for the predetermined price and sell the shares at the new, elevated price, making money in the process. In this situation, the more shares you purchase, the higher your return will be.
Another strategy is to leverage your risk by selling options. For example, if you own stock in a company, you can sell options to someone else, giving them the right to purchase your shares at a set price. This works well when the stock price is falling because the money you make from the options can offset some of the price decline.
Day traders can mitigate risk and leverage their money by trading options. Sign up with a brokerage firm and start taking advantage of this strategy today!
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