Is option trading risky?
Team Veye | 11-Nov-2019
An option is a contract that gives right but not the obligation to an investor to buy or sell shares of the underlying security at a predetermined price over a certain period of time.
While the option to buy at a specified price is a call option, the choice to sell similarly is a put option. When a buyer purchases an option on a futures contract, a premium has to be paid to the writer in exchange for the right to buy or sell that futures contract at a fixed price.
Options have become a popular trading tool for investors and hedge funds alike because of their ability to reduce the cost of risk through the reduction in the volatility of the underlying instrument. Investors can purchase a contract for a certain period of time with the option price being the present value of a future price at that time. This contract has no value until it is exercised, so it is easy to trade options on options.
Not only can one make more money with options trading, but can also manage risks. An investor can never lose more than what you originally paid for the call option contract, no matter how much the value of the stock may drop.
This means you can be in a position for as long as you like. The problem with options, however, is that there is a time limit for your options. If you do not exercise your call options within a certain amount of time, your contract is automatically canceled. You cannot simply exercise your options before the expiration date, and your stock can plummet to zero the moment you exercise your options.
The strike price determines whether the contract is in the money, at the money or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in-the-money because the holder of this call has the right to buy the stock at a price which is less than the price he would have to pay to buy the stock in the stock market. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be in-the-money because the holder of this put has the right to sell the stock at a price which is greater than the price he would receive selling the stock in the stock market. The opposite of in-the-money is out-of-the-money. If the strike price equals the current market price, the option is said to be at-the-money.
While the buyer of an option can lose just the premium paid, the seller, or a writer is at a much greater risk.
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