1. Options Basics: Introduction
  2. Options Basics: What Are Options?
  3. Options Basics: Why Use Options?
  4. Options Basics: How Options Work
  5. Options Basics: Types Of Options
  6. Options Basics: How To Read An Options Table
  7. Options Basics: Options Spreads
  8. Options Basics: Options Risks
  9. Options Basics: Conclusion

Nowadays, many investors' portfolios include investments such as mutual funds, stocks and bonds. But the variety of securities you have at your disposal does not end there. Another type of security, known as options, presents a world of opportunity to sophisticated investors who understand both the practical uses and inherent risks associated with this asset class.

The power of options lies in their versatility, and their ability to interact with traditional assets such as individual stocks. They enable you to adapt or adjust your position according to many market situations that may arise. For example, options can be used as an effective hedge against a declining stock market to limit downside losses. Options can be put to use for speculative purposes or to be exceedingly conservative, as you want. Using options is therefore best described as part of a larger strategy of investing.

[ Options have a reputation for being difficult to understand, but they are great tools for both hedging speculation when properly used. If you're interested in options trading, check out Investopedia's Options for Beginners Course that teaches you real strategies to increase consistency of returns and put the odds in your favor with over five hours of on-demand video, exercises, and interactive content. ]

This functional versatility, however, does not come without its costs. Options are complex securities and can be extremely risky if used improperly. This is why, when trading options with a broker, you'll often come across a disclaimer like the following:

Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.

Options belong to the larger group of securities known as derivatives. This word has come to be associated with excessive risk taking and having the ability crash economies. That perception, however, is broadly overblown. All “derivative” means is that its price is dependent on, or derived from the price of something else. Put this way, wine is a derivative of grapes; ketchup is a derivative of tomatoes. Options are derivatives of financial securities – their value depends on the price of some other asset. That is all derivative means, and there are many different types of securities that fall under the name derivatives, including futures, forwards, swaps (of which there are many types), and mortgage backed securities. In the 2008 crisis, it was mortgage backed securities and a particular type of swap that caused trouble. Options were largely blameless. (See also: 10 Options Strategies To Know.)

Properly knowing how options work, and how to use them appropriately can give you a real advantage in the market. If the speculative nature of options doesn't fit your style, no problem – you can use options without speculating. Even if you decide never to use options, however, it is important to understand how companies that you are investing in use them. Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another.

This tutorial will introduce you to the fundamentals of options. Keep in mind that most options traders have many years of experience, so don't expect to be an expert immediately after reading this tutorial. If you aren't familiar with how the stock market works, you might want to check out the Stock Basics tutorial first.


Options Basics: What Are Options?
Related Articles
  1. Trading

    The 4 Advantages of Options

    Flexible and cost efficient, options are more popular than ever. Find out why.
  2. Trading

    A Newbie's Guide to Reading an Options Chain

    Learning to understand the language of options chains will help you become a more effective options trader.
  3. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
Frequently Asked Questions
  1. What is the average return on equity for a company in the retail sector?

    Find out more about return on equity, how to calculate it and the average return on equity for companies in the retail sector.
  2. When did the Dow Jones Industrial Average (DJIA) begin?

    Discover how the Dow Jones Industrial Average, first published in 1896, was created as a way to inform investors of the overall ...
  3. Why Should an Investor Understand Accounting?

    Learn why an investor should understand business accounting to perform investment and credit analysis. Find out about asset ...
  4. How Can I Calculate Convexity in Excel?

    Learn how to approximate the effective convexity of a bond using Microsoft Excel using a modified and simpler version of ...
Trading Center