About Options Trading for Beginners
The options market is an investment medium that can seem confusing or even daunting to investors who are new to its concepts. Many beginning investors are interested in the world of options, but have few resources at their disposal with which they might come to understand them. Read on to learn more about options trading for beginners.
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History
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Options contracts began as actual paper contracts that investors used in various ways to try and increase their profits or hedge their investment positions. In their simplest form, options contracts are agreements in which investors make a commitment to either buy or sell a predetermined quantity of stock shares, usually being 100 shares per contract, on a specified date in the future.
Function
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Options contracts are useful in that they provide a way for stock holders to make additional money for investment by writing and selling the contracts on the market. For instance, if an investor holds 100 shares of company XYZ, and believes that the price of XYZ stock is going to drop in the near future, he can write and sell an options contract that will allow an investor to buy those shares at just below the current market price on the third Friday--which is the traditional day for contracts to expire--of next month. When the price drops below that of the agreed-upon contract price, the party who purchased the contract will not wish to purchase the stock, and the original investor gets to keep the price of the contract, thus profiting from the transaction and hedging his position in the market.
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Significance
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Stock options are frequently used by investors who do not own the underlying stock but wish to profit from the fluctuations in the underlying stock price. This is possible because the options contracts are a commodity that can be traded up until the moment of their expiration, given that the market wishes to purchase it, allowing investors to buy the contract and then sell it again at a later point in time without ever exercising the rights that the contract guarantees, but still profiting from the fluctuation in contract value.
Types
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There are two basic types of options contracts: put options and call options. Put options guarantee the right to sell a stock at a given price and a given time, while call options guarantee the right to buy a stock in the same respect. There are many possible combinations of calls and puts that have been termed as specific investment strategies. Some of these strategies are the iron butterfly, the iron condor and the straddle. Each of these strategies can be used in different market conditions to help ensure that investors profit from their transactions.
Effects
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Options offer a great deal of leverage over the market when compared to the amount of capital needed to purchase them. This basically means that an option contract for 100 shares of XYZ stock will cost significantly less than simply purchasing 100 shares of XYZ stock outright. To further this idea, the value of options contracts fluctuates to an equally greater degree than the value of their underlying asset, making options a very lucrative, but equally dangerous, investment medium.
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