How does options trading work?

Fsp Invest, 05 Dec. 2013

Tags: options trading, options, how does options trading work, how to options work, what are options, what is options trading



Options are sophisticated instruments and many investors don’t know how they work. Today, we reveal the details behind this great trading vehicle…
Essentially, an option is a contract that gives you (the buyer), the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.
Just like stocks or bonds, options are securities.
That’s a lot to wrap the mind around at first, so let’s take a look at how this principle works in the real world.


Options trading in action
Let’s say you’re searching for a flat and you finally find one you love. 
 
You don’t have the money to buy it at the time, but you know you’ll get the money in say three months from now. Perhaps you’re getting a bonus or a pay-out from an investment. 
 
So you decide to negotiate a deal with the estate agent. 
 
You make a deal that you have the option to buy the house in three months for the price of R1 million. 
 
But, for this option, you need to pay R30, 000 now to the estate agent. This amount is the premium you pay for taking the option. 
 
But what happens if the price of the house changes during that period? 
 
Well, you could either make or lose money. And the same is true of all forms of options trading. 
 
You see if the price of the house goes up, you get to buy it for cheaper than its real cost. You score!
 
But if the price drops… You overpay. 
 
And that’s the risk that comes along with options trading. 
 
You can get options for stocks or bonds or other securities. And the principle works the same way. 
 

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