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Options Trading

What is options trading?

Answer ...

Options are an agreement between two investors to either buy or sell an asset at a specified price at some point in the future. The key point to note is that the contract is written to show that you have the right, but not the obligation, to buy or sell the underlying asset.

In exchange for this right to exercise the option, the option holder has to pay a premium.

The options contract can be traded to other investors or you could decide to exercise your optional right on the underlying asset that you’re speculating on. Alternatively, if the payoff is not in your favour, you could let the option expire without exercising it and in that case you’ll lose the premium you paid.

Let’s consider two hypothetical situations that might arise and influence your decision to exercise this option:

1. You discover that a multinational corporation wants to buy your house to make space for a new set of office they want to create. The company offers you £500,000 for the house. As the homeowner sold you the option to buy the house, they are obliged to honour the contract and you stand to make a profit of £198,000 (£500,000 - £300,000 - £2000).

2. While inspecting the house, you discover that’s its build on poor foundations which are likely to subside in a few years. Luckily, as you have an option you are under no obligation to go through with the sale. Although you do lose the £2,000 premium that you paid for the option.

This example demonstrates that when you buy an option, you have a right but not an obligation to do something. You can always let the options expiration date go by, at which point the option becomes worthless. If this happens, you lose 100% of your investment, which is what you used to pay for the option.

Resource to help with trading: Alpha Forecast

Useful Videos...

Intro to options trading ...

Options basics

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