An options trader is anyone who buys and sells options in the capital market.
An options trader is anyone who buys and sells options in the capital market. As options trading is most commonly conducted through online option trading brokers, it is also commonly known as online options trading or online option trading. Option trading and stock trading are different on many levels.
Option trading and stock trading is different on many levels. Stock traders gain when the stock goes up, and lose when it goes down. It's that simple.
However, options traders (call and put premium buyers) not only need to pick the right direction of the stock, but the stock's move must happen in a certain amount of time (before the expiry date). Furthermore, there is a premium built in - the implied volatility (IV) - which tells us how much other call and put traders expect that stock to move. Therefore, not only do these speculators need the underlying to move in the right direction and within a certain time frame, but also by more than other players are predicting.
There are many advantages to options trading as an investment strategy but one of the main advantages is that trading options requires you to commit less capital to an investment than a stock or other type of market trade requires. By using an option you can make as much or more profit as with other types of trades. This can mean more money in your pocket for a smaller investment as can be realized in the example below.
An Example of an options trade - LinkedIn Corporation (Nasdaq: LNKD)
LinkedIn is the number one job search company, as it has become the go-to gold standard for job seekers and employers - which in turn has helped it double since its IPO two years ago.
On May 2, 2013, LNKD reached a peak of $201.67 and the next day fell back to $175.59. LNKD became range-bound, until signs indicated that there would be breakout occurring, therefore on June 21, 2013, the following options trade was executed.
OPTION TRADE: Buy the LNKD August 08, 2013 200.000 call (LNKD130808C00200000) at or under $4.00, good for the day. Place a protective stop limit at $1.60 and a pre-determined sell at $8.00.
By early July the trade had come to fruition. If it continued to be held, as of August 8, 2013, this trade could have been sold for $32.90 - a profit of 800%. However, greed can also cause a loss - therefore, 100% profit is better than nothing.
Reasons to trade stock options
In a volatile stock market, or even in a market that is flowing quietly and calmly, there are many reasons to trade stock options. The “flash-crash” markets, the volatility, the unexpected economic news reports and continuous data, the bull-runs, can all be beneficial to options traders if they so desire it.
By using options trading, options traders can avoid the stock market frustrations and actually set themselves up to make money. Options traders use strategies designed to extract money from the market, regardless of direction, or even if there is no direction, by using options.
Options traders can benefit greatly from their trades. For example:
- They can purchase a stock option for a fraction of the cost of buying the underlying stock, which means they can start trading stock options with a much smaller amount of money.
- They can make money when they trade stock options in any type of market - whether it is up, down or sideways - year-in year-out. Even if a stock they have purchased options on goes in a direction opposite to their views, then money can still be made with correct manipulation.
- They can profit in all market environments by trading multiple option strategies on highly liquid exchange-traded funds on broad-market indexes, like the QQQ.
- Their profit potential could be unlimited, depending on their trading outlook on the scale from conservatism to greed.
- They can profit from the strong tendency of the market to trade in well-defined ranges most of the time with a carefully selected option premium selling program.
- They can profit from the huge volatility around events like quarterly earnings reports.
- They can profit by buying call options on stocks that are in up trends, at much lower dollar risk than buying the stock.
- They can profit from market volatility regardless of the direction of the price movement.
- They can profit from buying calls on stocks that outperform, and at the same time buying puts on stocks that underperform their industry peers.
- Huge leveraged gains by buying options during expiration week, when premiums are extremely low. And now, with the new weekly options, there is an expiration week every week.
Their risk could be limited to the small amount they invest. The amount per investment needs to be considered, before the outlay, according to their risk scale and the amount of capital available.
They are able to still profit when they trade stock options in spite of interest rate fluctuations, inflation, deflation, or any political considerations, or even because of these factors. The more volatile a stock becomes, the larger the profit that can be expected from this options investment.
There are many advantages to options trading as an investment strategy. For one, it allows the options trader to commit less capital to an investment than would be required by a stock or other type of market trade. Even so, they can make as much or more profit as with other types of trades. This can mean more money in their pocket for a smaller investment.
Some of the other benefits that options traders have over other forms of trading are as follows:
- Leverage - The use of various strategies to maximize potential profit. Leverage is created by making the options trader’s investments work harder for them. In other words, leveraging is creating potential for bigger gains using a smaller amount of capital.
- Hedging - Traders can also completely hedge long-term stock positions at a low cost. In options trading, hedging means they can establish a position in one market (in this case options), to offset an exposure to price fluctuations in some opposite position in another market (here this means shares). This has the goal of minimizing their exposure to unwanted risk. Options are a perfect tool for protecting a stock portfolio. A trader can buy options on their stocks like buying insurance for a car. For a small amount of money they can buy options against a longer-term trade or investment and fully protect that trade or investment from market volatility (dramatic ups and downs).
- Trading up, down and sideways - Options give the trader plenty of extra scope to make leveraged bets on the direction of a stock; whether they believe the stock will go up, down, or move very little in any direction. This means that they can make money on stocks even when they are not making money.
- Less in commissions - This depends greatly on which brokerage the options trader uses. Online brokerages offer discounts on options as there is a great deal of competition. This helps to keep options trading costs low. Commissions on options are very open- there are no hidden costs. The commissions are a lot less than those charged for trading stock.
- Risk is limited - Options allow the trader to create trading strategies with limited risk of loss, but with high probabilities of success. They have complete control over the exposure to risk.
- Any movement can be good - An options trader does not need to be ‘bullish’ all the time. Options trading allows traders to establish positions that earn them money when the market moves up, down, or trades in a range. Owning shares only allows investors to profit when stocks move higher.
- Income - By selling someone else the right to buy their stock at a predetermined price, the trader is paid a premium that they can consider to be a special dividend through an option.
- Indexing - If an options trader wishes to trade a diversified portfolio rather than just shares, there are options available on all the major indexes e.g. S&P 500, DJIA (Dow Jones Industrial Average), Russell 2000, etc.
- Opportunity - Options are available in a wide range of instruments, such as agricultural products, metals, foreign currencies, interest rates, soft commodities, index products, energy products, etc. This leaves a wide scope for options trading opportunities at almost any time.
- Liquidity - Transactions can be executed quickly and easily, so the trader’s money is not tied up for a long time as it is in trading shares. The options trader can re-invest many times over in the same time that stock traders might, who only trades once with shares. This means many more chances to make a profit!
- Price availability - Options prices are readily available from a wide range of sources, particularly from the Internet. This makes it easy for traders to monitor market movement, find the best entry and exit points, and determine future positions.
Options are one of the most versatile trading instruments ever invented. They provide a high-leverage approach to trading that can significantly limit the overall risk of a trade, especially when combined with stock or futures. As a result, understanding how to develop profitable strategies using options can be extremely rewarding. The key when an options trader trades stock options is to develop an appreciation about how this investment vehicle works, what risks are involved, and the vast reward potential that can be unleashed with well-conceived and time-tested trading strategies.
The great thing about (stock) options is that once again the options trader will totally control their downside risk. So, even when they experience a losing trade, their loss will be strictly limited. They will draw the line on losses, in advance. It's a necessary built-in strategy in trading stock options.
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