Being a beginner at day trading may seem overwhelming at first, which is why it is important to know the options fundamentals. Fundamentals are so critical because it forms the grounding needed to learn. Talking about key concepts and their role helps you develop learners’ understanding and focus on what is important in day trading. Everything in a given discipline relies upon the basics to be successful.
In sports, you constantly hear the coaches preaching about the fundamentals; especially during practice. If your fundamentals don’t become instincts, then you will have trouble performing come game day. The way that you make the fundamentals become second nature to you is through constant learning and repetition. Just like this concept is applied in sports, it is also seen in day trading options. I will break down what an option is, options price, and call and put options in this article.
What Is an Option?
An option is a contract giving the buyer the right to buy or sell a basic asset at a specific strike price on or before a certain date. An option is a security, just like a stock or bond, and establishes a binding contract with strictly defined terms and properties. Options can enhance an individual’s portfolio. Options can accomplish this for an investor through added income, protection and even leverage. Depending on the situation, there is usually an option scenario appropriate for an investor’s goal in the stock market.
Options belong to the larger group of securities known as derivatives. A derivative’s price is dependent on the price of something else. Options can also generate income and, like anything else in life, options involve risk. When trading options with a broker, you will see warnings that the risks may not be suitable for everyone. The two option types that we will go into further detail about are call and put.
Options Fundamentals: Call and Put Options
A call option gives you the right to buy a stock and a put option gives you the right to sell the stock; there is no obligation to buy. If you believe the market is trending upwards, you would purchase a call option. You would then hold onto that contact until you felt it was time to sell due to following a strategy in which the target area was touched. The other reason for exiting your position would be if you noticed the market quickly turned against you, and you have to sell to minimize your loses. The final reason to leave an existing position would be the specified period your stock options are valid for its expiration dates. You would not want your options contracts to expire because they would have no value.
If you felt the market was trending downwards, you would purchase, and put contracts. You would then sell your contracts once you made a profit following your strategy in which the target area was touched. The other reason for exiting your trade would be if the market turned against you and started to move upwards. In order to minimize your loss, you would have to sell your contracts. With either put or call contracts, you cannot lose more than what your initial premium paid was. Which to a certain degree does give day traders peace of mind.
In terms of understanding option contracts, it is basically all about defining the probabilities of future price events. The more likely something is to occur, the more expensive an option that profits from that event would be. For instance, a call value goes up as the stock (underlying) goes up. This is important in comprehending the relative value of options. The less time there is until expiry, the less value an option will have. This is because the chances of a price move in the underlying stock diminish as we get closer to expiry. On most U.S. exchanges, a stock option contract is the option to buy or sell 100 shares; that’s why you must multiply the contract premium by 100 to get the total amount you’ll have to spend to buy the call options.
Volatility also increases the price of a stock. This is because uncertainty pushes the odds of an outcome higher. If the volatility of the underlying asset increases, larger price swings increase the opportunities for substantial moves both up and down. Greater price swings will increase the chances of an event occurring. Therefore, the greater the volatility, the greater the price of the option. Options trading and volatility are essentially linked to each other in this way.
Instabilities in option prices can be explained by intrinsic value and extrinsic value; which is also known as time value. An option’s premium is the combination of its intrinsic value and time value. Intrinsic value is the in-the-money amount of an options contract, which, for a call option, is the amount above the strike price that the stock is trading. Time value represents the added value an investor has to pay for an option above the intrinsic value. Options for the most part trade at some level above their intrinsic value, because the probability of an event occurring is never absolutely zero, even if it is highly unlikely.
A few important characteristics of options are strike price, expiration date, and option price. Strike prices are defined as the price at which an option can be exercised; the current price. The expiration date is the date on which an option expires and becomes worthless. An option’s price is defined as the price at which an option is purchased. Call and put options are generally taxed based on their holding duration, they acquire capital gains taxes. You will need a trading platform to engage in
Another thing that is important to know is once you purchase an options contract to sell the same day. Although you can hold a trade overnight, it is not recommended to do so because you put yourself at a higher risk of losing more money. The reason for this is that the market opening gap can be lowered that the price you purchased your option for the day prior. Even with a losing trade, it is better to close out and start fresh with new trades the next day.
Summary: Options Fundamentals for Beginners
You have just learned about options prices, falling prices, when to sell options, when you become the option sellers and the option buyers. These things are the backbone to being successful in day trading. Bruce Lee said, “I fear not the man who has practiced 10,00 kicks once, but I fear the man who has practiced one kick 10,000 times”. Why is this? Because repetition makes you a master at your craft. Knowing the options basics are important to get started on your day trading journey, however it will require practice of a tested strategy and dedication to be continuously successful in this field. When we turn our back on the basics, the end result is rarely ever positive. Failure humbles us and reminds us to go back to the start.
Basic skills are the bread and butter for any field, the MK VIP training has plenty of resources to help you get started on reaching your day trading goals. Now that you have the fundamentals of options down, I can teach you options strategies that if you put in the work and practice, you will be successful for at least 80% if not more of your trades. My goal has always been to help as many day traders achieve their personal financial goals, whether they are novice traders or experienced traders.
Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, and options trading strategy. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
Feel free to check out other FREE educational resources to help guide you as you begin your new journey to financial freedom.
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