In order to help your understanding options trading better, George Fontanills explains this in his book, Options Trading for Dummies. Below is an excerpt from that book.
Option contract can be used for financial hedges or tools for speculating. When purchasing an option contract you have the ability to exercise your rights or simply trade those rights away. Different needs and conditions will dictate different actions. You want to be prepared to properly assess the situation so you do what’s best. Exercising an option to minimize stock risk is just one way you put options to work for you.
Understanding options trading is a natural step forward if you are already managing your own portfolio.
Reasonably reducing risk is the name of the game in investing, so it’s very useful to know ways you can protect existing positions and strategies by adding options to them. Protection can be put in place on a position-by-position basis or by hedging the whole portfolio. If instead of a bearish short-term outlook that requires hedging, your view becomes so negative that you’re seeking bearish trading opportunities, options offer a much safer option approach that short selling a stock or sector. Chapter identifies some hedging techniques.
Another way options can do some heavy lifting for your investments is through the use of leverage. By spending less on as an initial investment you satisfy a reduced risk approach, but that doesn’t mean you must realize reduced returns. Basic strategies can help you accomplish both. And if speculating is part of modus operandi, you can risk even less when willing to cap your profits.
Understanding options (trading) styles
There is a primary focus on stock options in this book, but it’s hard to ignore another big segment of the market….that is the index market. The glaring index between a stock and in index is that the stock can is a security that can be traded. An index cannot. This means index option exercise takes on a whole new dimension. Because this is not the only difference between the two option types, it’s important to grasp how your rights and trading are affected by the style of the option you decide to use.
When trying to make an effort in understanding options trading, there are many invaluable lessons in the book, options trading for dummies.