Things You Need to Know before Starting to Trade Options

The options trading process requires basic knowledge about its specific instruments and terminology. There are a lot of terms and financial tools that you need to study carefully in order to understand the role of each player and to determine the chances of making money in this field. This piece of writing will take you closer to the options world.

What is an Option?

An option contract confers the right to buy or sell an asset with a predetermined price by a set date. Usually, the assets traded are stocks. There are two parties involved in the trading process: the buyer, known as the holder, who has  to decide if he wants to exercise his right or not, and the seller, called the writer, who is obliged by the contract terms to complete the option transaction if the buyer makes the decision to use his right. Contrary to European options, American options can be exercised at any time up until their expiration date.

Types of Options

The call option allows the holder to buy the underlying stock at a particular price, called strike price, before the fixed period of time expires and obliges the writer to sell the stock at the strike price if the holder exercises the option. The holder of a put option has the right to sell the asset at the specified price during the established period of time, while the writer has to purchase the underlying security at the strike price if the holder executes the option. In both cases, the writer receives a premium, which is paid by the holder, for taking the risks related to the obligation.

Cash Account and Margin Account

If you have just started to learn options trading, you should be aware that it takes time to deal with all the new information. The first step is to open a trading account with a firm specialising in brokerage. Your broker will be authorised to buy or sell securities on your behalf. You have two categories of accounts to choose from: the cash account and the margin account. With a cash account, you only have the effective cash at your disposal to pay for stocks and trades. With a margin account, on the other hand, you can use the stocks you own to get funds from the brokerage for new purchases. There is a minimum deposit necessary to open a trading account, which is regulated by margin account laws. The deposit for a cash account depends on the policies of the brokerage company.

These days, online brokerages tend to take the place of traditional phone discussions with human brokers. Using advanced interfaces, online brokerages can process thousands of orders at the same time with higher accuracy and lower costs. However, when you are a beginner it is more desirable to interact with a real broker in order to get the most out of the experience and utilise the knowledge that he has acquired over time.

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