Learning How to Invest in Options: Guide for Beginners
Options contracts are often one of the most misunderstood investment strategies that beginners are afraid to touch. Fortunately, understanding options is not as difficult as it may seem. It only takes a few moments to learn the basics. Our article is going to offer five tips to help teach you how to invest in options.
1. Learning the Lingo
The first and most important tip to remember when learning how to invest in options is to learn the lingo associated with options trading. Just like any investment product, options contracts are filled with a wide range of unique terms that can often be confusing for beginners.
For starters, an option is a contract that gives the holder a right to buy or sell an investment at a certain price. An important note to remember is that an option holder is not obligated to buy or sell their investment at the agreed upon date. As for the buy and sell options, they each have their own unique names.
When you initiate an offer to buy an option at a future date and time, this is called a call option. Call options are always classified as a long investment strategy when you are considered the owner of one. As for a sell option, this is called a put. The opposite holds true with puts and a put owner will always follow a short investment strategy with this option
People who hold call and put options are called buyers. For people who sell their buy and put options, they are called sellers. The important distinction between the two is that buyers are not obligated to buy or sell their options contracts. On the other hand, sellers are expected to fulfill the options order requirements. In most cases, investors are considered buyers.
Another term that relates to both put and call options is the strike price. The strike price is the value at which the investment can be bought or sold and is detailed in the options contract. The expiration date, otherwise known as the expiry, is the date that your option contract ceases to be valid.
2. Understand the Primary Use of Options
The second tip to consider when you are first learning how to invest in options is to understand their primary purpose. Keep in mind, options are not intended to serve as a gamble for the market. Instead, you should use them to reduce your investment risks as much as possible.
You can do this by reviewing various graphs and reports that show an investment’s performance over a given period of time. If it looks like the price is likely going to continue rising in the future, a call option may be in order. Using a call option can allow you to purchase the price at a lower value than what the market is currently displaying.
The opposite holds true with put options. If you are noticing that a stock or investment is declining in value, a put option can give you the ability to reduce or eliminate your losses with the given investment. Keep in mind that put options are a bit harder to predict; you will likely need to review performance figures much more closely for these contracts.
3. Don’t Forget about Premiums
When learning how to invest in options, you must never forget about the cost of premiums. While you are not obligated to exercise a put or call option as a buyer, you still end up eating the cost of the premium in the event that you decide not to use your call or put contract.
The premium is the amount you pay for the right to exercise a buy or put option. The amount can vary substantially based on a variety of factors like the investment’s prior performance, its current price, as well as the trading volume associated with the investment. No matter what, you will always lose the money that you initially paid for the premium. This is true regardless if you decide to exercise your buy or put option.
4. Keep Your Cool
This is one tip that is applicable to learning how to invest in options and investing in general. The world of investing is meant to be one of calculated risks and returns. Your emotional state should never play a role in your decision-making process when deciding to buy or sell a stock.
Prime examples of things that can negatively impact your judgment include stressful work events, arguments with friends and family, and just general daily frustrations like dealing with traffic. With this in mind, it’s always best to allow yourself ample time to cool off after these types of events before making an investment decision.
A great idea to consider is yoga or meditation. The breathing exercises that these types of practices teach can help to clear your head as well as reduce your blood pressure. If you’re not the type to enjoy yoga or meditation, consider a physical activity like jogging or weight lifting. No matter what, channeling your stress into a positive activity can really help with shrugging off that daily pent-up tension.
5. Understand the Financial Requirements
The fifth tip to remember when learning how to invest in options is to understand the financial requirements. When you use a put or call option, you are opting to buy or sell 100 shares of a given investment product.
In some cases, the price of the investment may not be that high and a smaller investor can afford to absorb the cost easily. However, many larger investments can cost significantly more money than a beginner investor can afford. With this in mind, always make sure that your buy and put options fall safely within your operating budget and do not put you in a position where you are struggling with cash liquidity.
Drawing to a Close
As you can see, learning how to invest in options isn’t quite as difficult as it may have initially seemed. By following the five tips outlined in our article, you should be well on your way to making informed investment decisions.