In the context of trading, an option is essentially a contract that gives the buyer the right. This right allows them to buy or sell an underlying asset at a set price. The set price is also called the strike price. The option must be exercised before a specific expiration date. The underlying asset can vary, ranging from forex to stocks, commodities to indices, and more.
Two primary types of options are:
- Call options: gives the trader the right to buy the underlying asset at the strike price within a specific time frame.
- Put options: gives the trader the right to sell the underlying asset at the strike price within a particular time frame.
You can use options in many different ways. Let’s look at some examples:
Gold call option
Imagine, for example, you expect the price of gold to rise from $1,800 to $1,900 per ounce in the next few weeks. You decide to purchase a call option. This option gives you the right to buy gold at $1,850 per ounce. You can exercise this option at any time within the following month. The cost you pay to acquire this option is called the “premium”.
If, however, the price of gold rises above $1,850 (the ‘strike’ price) before your option expires, you’ll have the opportunity to buy it at a discount. If the price stays below $1,850, you don’t have to exercise your option and can let it expire. In this case, your only loss will be the premium paid to open the position.
Currency pull option
Let’s say that you predict the EUR/USD exchange rate will fall from 1.10 to 1.08 in the next couple of weeks. You opt to purchase a put option. This gives you the right to sell EUR/USD at 1.09. You can exercise this option at any point within the next month.
If the EUR/USD exchange rate drops below 1.09 (the strike price) before the option expires, you can sell at a more favorable rate. If the exchange rate stays above 1.09, you don’t have to exercise the option. You can let it expire, and your only loss will be the premium paid to open the position.
Why opt for options trading?
There are several reasons one would choose to trade options. Firstly, the trader has no obligation to buy or sell the underlying asset.
Secondly, options trading offers the potential for making a profit within short or medium timeframes, and regardless of whether the market is bullish, bearish, or static.
Third, the use of leverage enables the trader to handle larger positions at a fraction of the cost. However, while leverage can amplify profits considerably, it can also magnify losses to the extent that the trader loses all their capital. This is why risk management is key.
That said, options investing offers a higher level of transparency, as the trader knows their potential loss upfront, which is limited to the premium paid. As with all trading strategies, trading options also comes with its inherent challenges.
For example, if the price of the underlying asset moves in the adverse direction, the options contract may become worthless. In this case, you will likely lose the premium you paid. This is unlike stocks, where you still retain ownership of the stocks. Regardless of whether their value rises or falls, you hold on to the stocks.
Options trading may also come off as relatively complex, particularly if you are a beginner trader. This is why its important to not dive all in, but instead start small until you’ve acquired a robust understanding of trading options and have boosted your skills.
If you are using leverage, know that your risk for large losses increases exponentially. You must know how to effectively manage leverage and not lose control in the process of trading.
Learning how to trade options
There are many ways for a trader to learn how to trade options. The first step is to learn the fundamental basics. Ensure you understand what options are and how they differ from stocks. Get your hands on physical books or read blogs or articles.
Consider undertaking courses, attending webinars or even in person seminars oe exhibitions. Watch videos หรือ listen to podcasts. Join online community forums to engage with other traders to share insights and concepts.
Integrated into this learning should the study of risk management techniques to protect your funds. This may include optimal position sizing, portfolio diversification, setting stop-loss or take-profit orders, and so forth.
Also monitor the news and economic releases to mitigate any real time market moving events. Another crucial component of the learning process is gaining practical trading experience and one of the ways to do this is to sign up for a demo trading account.
By why? Well, for many reasons:
- A demo trading account offers a simulated trading environment which mimics real life market conditions, allowing you to get a realistic feel for what trading will look like.
- A demo account allows you to trade with virtual funds, giving you the peace of mind to practice trading without worrying about loss.
- Most importantly, a demo trading account gives you the opportunity to learn how to use technical analysis, a key component of deciding whether to enter or exit a trade. If you sign up for a demo account with T4Trade, you’ll also gain access to the MetaTrader 4 platform, one of the most popular trading systems in the world.
Finally, before you start down the path of options trading, first establish whether options trading is for you. Ask yourself whether you are comfortable with the level of risk that this form of trading may impose.
Ensure you’ve learned everything you can about options trading—and be honest with yourself—to avoid critical gaps in knowledge that could lead to uninformed decisions and poor financial outcomes.
Consider creating a trading plan first as well. Regardless of your approach to trading, a plan is essential for maintaining discipline and focus. It sets out the rules by which you’ll trade, with little deviations unless absolutely required. In this way, you’ll likely make trades based on objective data rather than emotional impulses.
Key terms in options trading
In summary, key terms to remember if you’re only now about to embark on options are:
- Underlying asset which is financial instrument that the options contract is based on.
- Strike price is the predetermined price at which the option holder can buy or sell the option contract.
- Premium which is the price paid by the buyer to buy the option.
- Expiration date which is the deadline by which the buyer must choose to exercise the option or let it lapse.
Trading with T4Trade
T4Trade has established a robust reputation, appealing to traders in many countries across the globe. T4Trade ticks many of the boxes we’ve mentioned in the article in terms of regulation, reliability, learning opportunities, and more.
Other reasons that traders choose T4Trade are that it offers competitive spreads, flexible leverage, and quick and easy withdrawals and deposits.
T4Trade also provides multiple account types to choose from, meeting the demands of traders at all levels. Its trading platform, MT4, is user-friendly, and feature rich, offering an optimal trading experience.
T4Trade’s multilingual customer support is top-tier and on hand 24/5 to help you with any pressing trading related queries. Further, T4Trade offers access to high-end educational resources to help you become a better trader.
Disclaimer: This material is for general informational and educational purposes only and should not be considered investment advice or an investment recommendation. T4Trade is not responsible for any data provided by third parties referenced or hyperlinked in this communication.
