How Options Trading Works

Written by on July 21, 2020 in Business, Investing and Insurance with 0 Comments

Options are powerful financial instruments that allow but do not require the bearer to buy or sell an underlying security or asset at a predetermined price before the expiration of the contract. They can be bought or sold on the options market through retail or online brokers like most other classes of assets with investment accounts. When as an investor you purchase shares at a later time usually at a stated price but within a specific period, it is referred to as “call option” while those that allow an investor to sell at a stated price but within a specific period are “put option”.

In buying or selling options, every contract has a specific expiration date in which the trader or investor can exercise their option, but it is not mandatory to do so at this point. As a result of this, they are considered derivative securities, meaning that its price is derived from other things such as the underlying instruments and this makes them less risky than stocks when they are used correctly. Some examples of these derivatives are calls, puts, swaps, futures, forwards, and so on. You can read more on this here.

The price stated on an option is referred to as strike price and it is a percentage of an underlying asset. They are not the same as stocks as they do not mean that a person owns a part of a company. You can always walk away from a contract whenever you like.

These kinds of financial instruments can add to an investor’s portfolio protection, added income, and a form of leverage. They are used in generating recurring income and for speculations when wagering on the directions that stocks will go.


There are two major types which are the American and the European. This is not based on any geographical location but the time in which it can be exercised. The American can be exercised at any time between purchase and expiry while the European are exercised at expiration. There are also other types including Asian, Bermudian, exotic, and binary options.

How it Works

The value of an option is about speculating and determining the chances of future price events. This means that the higher the probability of something occurring, the more expensive the option that profits from the event will be. Also, the more the period before its expiry, the less the value will be since the chances of a price move reduces as the expiry draws close. Time is an important component when it comes to options. The more time available, the more the chances of a price move in an investor’s favor while the less the time, the less the chances of a favorable price move.

Asides time, another factor that affects its value is volatility. This is because the odds become greater when there is uncertainty. Large swings in prices will increase the possibilities of substantial moves and the greater the price, the greater the probability of an event occurring. This means that the greater the volatility, the more the value of the option. You can see the different reviews at to get a better understanding.

How to Trade

Trading options involves certain risks that you must be aware of as an investor. You will always see brokers give a disclaimer as a result of this stating that it is speculative and that there the risk of loss.

Due to its complex nature of this investment instrument and the amount of funds involved, before you start trading, you need to clear a few hurdles. Brokerage firms will usually screen potential investors to try to know more about them, their experiences when it comes to trading and how much they understand the risks before awarding a permission slip to begin trading. Some of the things you will need to provide include:

  • What your investment objectives are
  • Your trading experience; the length of time you have been involved in trading stocks, how knowledgeable you are when it comes to investing, how many trades per year you make and also the size of these trades.
  • Your personal information; net worth, employment, and annual income.
  • The kind of options that you desire.

Based on your responses to the above, the broker will give you a trading level which can be anything between 1 and 4. This serves as your pass to trading certain options types.

As an investor, it is your duty to choose a broker to trade with. Find one with experience, knowledge, tools, and a willingness to offer guidance and support especially if you are new to this kind of trading.

The Elements Involved in Trading Options

Taking out an option means buying a contract to sell or buying a stock which is usually 100 shares per contract at an already negotiated price and date. To do this, you need to

  • Speculate on the direction the stock will move. This will determine which of the types of options contract you get; whether a call or a put.
  • Predict the price move.
  • Determine the time frame the stock will likely move

When you have been able to determine these, you can then go ahead and either buy or sell.


Whether you are a new comer to investment or not, trading options can be very interesting and serve as a means of income or leverage for you. Ensure you do a proper research and get all the information needed before delving into it. Also, you should choose a broker or brokerage firm that is not only knowledge or experienced but also ready to offer guidance and support when you need it.

Tags: , , ,


If you enjoyed this article, subscribe now to receive more just like it.

Subscribe via RSS Feed Connect on YouTube

Leave a Reply

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.

FAIR USE NOTICE. Many of the articles on this site contain copyrighted material whose use has not been specifically authorized by the copyright owner. We are making this material available in an effort to advance the understanding of environmental issues, human rights, economic and political democracy, and issues of social justice. We believe this constitutes a 'fair use' of the copyrighted material as provided for in Section 107 of the US Copyright Law which contains a list of the various purposes for which the reproduction of a particular work may be considered fair, such as criticism, comment, news reporting, teaching, scholarship, and research. If you wish to use such copyrighted material for purposes of your own that go beyond 'fair use' must obtain permission from the copyright owner. And, if you are a copyright owner who wishes to have your content removed, let us know via the "Contact Us" link at the top of the site, and we will promptly remove it.

The information on this site is provided for educational and entertainment purposes only. It is not intended as a substitute for professional advice of any kind. Conscious Life News assumes no responsibility for the use or misuse of this material. Your use of this website indicates your agreement to these terms.

Paid advertising on Conscious Life News may not represent the views and opinions of this website and its contributors. No endorsement of products and services advertised is either expressed or implied.
Send this to a friend