If you want to know what is options trading then just think of options as you would the word itself. An option allows you to do something at a later date. In financial markets, this basically translates in to a right to buy or sell a stock at a later date in exchange for paying a premium to own the option to do so. This might sound convoluted so let’s take a closer look at a simple option transaction. Now knowing what is options trading, does not make an options trader. If you really want to learn options trading, putting the above explanation to a real world trading scenario will help you grasp the concept better.
So exactly what is options trading?
Then we check the Yahoo finance options market for Apple stock, concentrating on the January 2012 delivery.
A lot of investors cannot afford the high price of some stocks such as Apple for example which often trades in the hundreds of dollars per share. If you multiply that by just a single board lot of 100 shares, that’s about a $38,000 dollar investment on November 14th, 2011, so no wonder that this is an arena for fund managers. But with options, you can still participate in such speculation.
Let’s say that in 3 months time you think Apple will zoom to $450 or even higher. Let’s look at January’s options here on Yahoo Finance and you can see a myriad of options available. This market is almost just as busy as the stock trading itself.
If we look at this area here divided by a yellow and white background, this shows where the price of the stock is currently trading. The yellow shading represents options that are currently in the money, and the white background shows options which are currently out of the money. If you were selling your option today, you would definitely want to be in the money. This is a key concept when trying to understand what is options trading.
If you think about what is options trading, in the money is a very important concept to understand.
Now look down to the strike price of $450 in the January options. That call option is trading at $3 right now. Meaning that if you own that option you can buy the right to own 1 share of Apple stock at the $450 near the end January 2012.
Now going back to your prediction that Apple will be trading at $50 in January, then it doesn’t really make much sense to be owning this option now, because you could (if your prediction is correct), just go buy the stock in the market. Let’s assume, you do not want to own the stock, but make money on where you think it’s going. (Most options traders use this approach after they really understand exactly what is options trading.)
So let’s look at another strike price of perhaps $410, which is currently trading at $11.40.
Now if Apple stock is trading at $450 in January, then if you would have bought in November 2011 this call option would be in the money, to the tune of about $40. $40-$11.40=$28.60 That’s an ROI of 250%, at least on paper anyway.
What we’ve just discussed here is the premise of the entire options market, which is, what do you think is going to happen, and how much are you willing to pay to prove you are correct? That is key to understanding what is options trading and only then can you envision potentially profitable situations.