Basic Stock Option Trade Information: What Every Investor Needs to Know

Stock option trade is one of the more popular forms of investment. Like other investment types, it has its own pros and cons. Some individual investors might think that stock option trading is an easy way to make money; in this, they are both right and wrong. It does have its advantages, but it also comes with risks. Below is a discussion of its features.

What it is

A stock option is a contract that provides the buyer the right, but not necessarily the obligation, to sell or buy an asset that could be in the form of a property, stock, a futures contract or other forms of underlying security. In return, the seller of the option gets a premium or payment from the buyer of the option. Option buyers have the right to buy or sell their options at a set price on or before the expiration date specified in the contract.

Advantages and risks

According to market analysts, option trading offers the advantage of having the risks quantified, hence providing a better degree of precision compared with other forms of investments. However, just like all kinds of securities, it does have its risks, primary of which is the return's non-linear variation with the value of the underlier and other related factors. Moreover, the risks associated with options are more complicated and less easy to predict than other forms of investments.

Call vs put and types of options

A call option gives the buyer the right to buy a particular asset, while a put option provides the right to sell. These two are the most basic forms. Under these forms, there are a number of types. First are the listed or the exchange-traded options. These have standardized contracts and maybe in the form of stock options, futures contracts, equity, bond, commodity and interest rate options.

Other types include employee stock options and over-the-counter options. The former are issued by a company to its employers as part of their compensation benefits, while the latter are those not listed on a stock exchange and are traded between two private parties. Over the counter or dealer options have various types; and these are: swaps, interest rate options and currency cross rates.

Trading methods

Options can be traded through contracts that are listed in futures and options exchanges. In the case of over-the-counter options, contracts are established between two independent entities without the help of exchanges. Employee stock options, on the other hand, are exercised by the original holder, unless they are allowed to expire as worthless.

Stock option trade is considered by some as relatively safer than other forms of trading. But market analysts have warned that there is no such thing as a safe bet when it comes to trading. The best thing investors can do is to make sure that they know everything they could about an investment form, be it stocks or options or any other kind of trading tool.