Stock Options Explained – How Does Options Trading Work?

If you are a newcomer to the field of options trading, and going through the process of getting stock options explained, you might be wondering how options actually work and how they make profit. Although options trading does not require huge amount of investment as like direct stock trading, it can produce very high ROI only depending on market changes. You will be amazed to know how options trading can get almost unlimited potential of profit with a very limited amount of risk.

But at first, you need to know what stock options really are. To get stock options explained in simple words, they are just some contracts between you and the option writer. They give you the right for a future transaction of some stocks at a set price. Using this contract, you can buy or sell the stocks later at the price defined at the contract. This defined price is called strike price and it is the main element that makes the profit from the options. Also, these contracts have a time limit or expiry date, and if the transaction is not made before that the contract is rendered useless.

Then there are two types of option; one is call option which is the right to buy stocks, and another is put options giving the right to sell stocks. They both have their different ways of making profit.

Call options are simple contracts that give you the right to buy some stocks before the expiration date at the strike price. It is the most profitable mode of option if applied correctly. In this case, if the price of the stock rises above the strike price before the expiration of the contract, you can buy the stocks at the strike price and sell them at the higher market price. Your profit should be the difference between the strike price and the market price minus the price of the contract. As the market price can rise to a level of infinity, the window for profit is infinite. But if the price fall or does not rise above the strike price, you face losses which is only limited to the price of the contract.

In case of put options, getting the stock options explained is a little more complicated. In put options, you buy the right for selling some stocks at the strike price. In that case, if the actual price of the stock falls, you are guaranteed the strike price for selling the stock so there is not much loss as it would have been by selling the stock at the market price.  But if the price increases, you do not need the option as you can directly make profit from selling the stocks. Often, put options are bought alongside call options to reduce the risk of losses. Sometimes, the put options are bought for stocks that are not already owned. In that case, if the price of the stocks falls, the option holder can buy them at lower price, and sell them at strike price to make profit. But this is process possess a good amount of risk.

So, if it is clear to you so far, you must be able to see how profits can be made using options trading. If you want to get stock options explained to you even more clearly, you can try seeking help from licensed institutions and brokers. They can even provide you virtual trading environments where you can try out your knowledge.

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