Equity option trading refers to investors buying or selling the right to purchase or sell 100 shares of an underlying stock before the options contract expires. This right may be exercised only when the strike price, which is set somewhere above or below the underlying stock's current price depending on the option type, is reached. Investors who practice equity option trading must anticipate both the movement of the underlying security and the timing of that expected move. For that reason, investors should develop sound strategies to minimize risk in their options trades while still taking advantage of profitable opportunities.
Trading equity options can be intimidating to novice investors based simply on the amount of terminology they must learn. In equity option trading, the trader can either buy or sell calls, which are the right to buy 100 shares of an underlying security, or puts, which are the right to sell 100 shares of the security. The strike price, set above the current price of the underlying stock for calls and below it for puts, is the point at which the option may be exercised by the option buyer. When that occurs, which must happen before the predetermined expiration date, the option seller, or writer, must fulfill her obligation.
The safest way to practice equity option trading is to buy options. When buying an option, an investor is only at risk of losing the premium, which is the initial price paid for the option. On the other hand, the possibility for gain for the option buyer is limitless, depending on how far the stock price exceeds, for call options, or goes under, for put options, the strike price. Investors can cash in by either exercising the profitable option or closing the option out by selling it back on the market.
Selling options is a far trickier maneuver on the equity option trading market. This is because sellers are required to fulfill the contract if the strike price is reached, and that can be devastating if the underlying stock moves way into the money for the buyer. For that reason, the seller should consider buying shares of the option's underlying stock. Such a maneuver would act as a hedge against the price moving one way or the other.
Developing analytical techniques to gauge the movement of securities is a crucial element of equity option trading. The successful options trader should be able to spot trends on the market as a whole as well as in separate sectors. Determining whether the market is bullish, meaning it is moving in an upward direction, or bearish, meaning it is moving downward, will go a long way to determine how individual stocks are going to move.
