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Stock Options Guide

Updated: Jul 4

If you are interested in leveraging your cash, you may want to check out Stock Options. Options allow you to control more shares of stock than the traditional way of buying and selling a stock.


Options trading may seem overwhelming at first, but it's easy to understand if you know a few key points. Investor portfolios are usually constructed with several asset classes. These may be stocks, bonds, ETFs, and even mutual funds. Options are another asset class, and when used correctly, they offer many advantages that trading stocks and ETFs alone cannot.


We've put together 2 options resources for you to get started.


Resource #1

The first resource is Investopedia and you can find their online Options Trading Guide Here


Resource #2

The second resource is from Options Made Easy, you can find their book below:


Stock Options Guide
.pdf
Download PDF • 11.31MB



Advantages

Advantages of Options Trading:

There are many advantages of trading options over the future and cash. There are several advantages are given below-


Cost Efficient:

Options come up with huge leveraging power. A trader or investor can get options position equal to a stock position at a much lower margin. For example, in order to purchase 200 shares of a stock at price 80, an investor requires paying Rs. 16000. However, if he was to purchase call options of equal weightage, the premium required would be around Rs 4000. So we can have a fair idea of options cost efficiency.


High Return Potential:

The returns on options trading would be much higher than buying shares on cash. As such, the option pays equal profit as the simple stock buying if had chosen the right strike. As we are getting options on lower margin and getting the same profitability the percentage return would be much higher comparatively.


Lower Risk:

Options are riskier than owning equities however; there are also times when options are used to avoid risk. Options are used widely to hedge the positions. The risk in options is predefined as the maximum loss can be the premium paid to buy the option.


More Strategies Available:

There are more strategies available in the options market to trade options. The trades can be combined to create a strategic position with the help of a call and put options of different expiries and strike prices.


Disadvantages

Disadvantages of options:

As we have seen above that options can be highly rewarding however, there are some drawbacks of options trading. These are some key drawbacks of options explained below-


Less Liquidity:

Some stock options have lower liquidity which makes it very difficult for a trader to make entry and exit from the trade.


High Commissions:

Option trading is more expensive as compared to future or stock trading. However, there are some discount brokers that give the opportunity to traders to trade on lower commissions. But most of the full-service brokers charge higher fees for trading in options.


Time Decay:

Time decay is a worse thing while trading options. The value of your option premium decreases by some percentages each day irrespective of movement in the underlying.


Non Availability of All Stock Options:

All the stocks registered with exchanges do not have options contracts. This makes it difficult for a trader to hedge his position with options strategies.



Conclusion:

Options can be bought and sold each situation has its own advantages and drawbacks. Time is a key thing in trading the options as time decay runs against the buyer of the option. Trading cost is also a critical thing to consider while trading options. Options trading is more difficult to understand for a layman so you need to be careful while trading options.


Key Takeaways
  • An option is a contract giving the buyer the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date.

  • People use options for income, to speculate, and to hedge risk.

  • Options are known as derivatives because they derive their value from an underlying asset.

  • A stock option contract typically represents 100 shares of the underlying stock, but options may be written on any sort of underlying asset from bonds to currencies to commodities.