When you trade options, you can make two basic types of trades: opening a position and closing a position. An opening position is when you first buy or sell an option, and a closing position is when you offset that initial trade by making the opposite transaction. You can also close out an options contract before it expires, known as exercising your option.
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Positions you can take trading options
You can take four positions with options contracts: long, short, straddle and spread. In a long position, you purchase an option with the intent to sell it later for a profit. A short position is when you sell an option in hopes of repurchasing it at a lower price later.
A straddle combines a long and short position where you purchase both a put and call option with the same strike price and expiration date. This strategy is used when you expect the underlying asset’s price to fluctuate significantly, but you’re unsure which direction it will go.
Finally, a spread is when you purchase one option and sell another option with a different strike price or expiration date. Spreads can be either long or short, bullish or bearish. The most common type of spread is the vertical spread, simply two options with different strike prices but the same expiration date.
Determine your strategy
The first step in trading options is deciding what type of trade you want. Are you looking to take a long or short position? Do you want to buy or sell an option? There are a variety of strategies you can use, and the one you choose will depend on your investment goals.
If you’re bullish on a particular stock, you might want to consider opening an extended position, which means you would purchase call options on the stock with the intent to sell them later for a profit. If you think the stock will drop in value, you could open a short position by selling put options.
Choose your options
Once you’ve decided on a strategy, you must choose the specific options you want to trade. For example, if you’re going to open a long position on a stock, you need to decide which call option you want to purchase. The strike price is how much you can exercise the option for, and the expiration date is when the option expires.
When choosing an options contract, you also need to consider the premium. The premium is the option’s price, determined by several factors, including the underlying asset’s price, the strike price, the expiration date, and the underlying asset’s volatility.
Place your trade
Once you’ve chosen your options, it’s time to place your trade. You can do this using a broker or an online trading platform. When placing a trade, you need to specify the type of option, the strike price, the expiration date, and the premium.
You must also decide how many contracts you want to buy or sell. One contract typically represents 100 shares of the underlying asset. So if you’re buying two contracts, that would equal 200 shares.
Monitor your trade
After you’ve placed your trade, you need to monitor it and make sure it’s going as planned, which means keeping an eye on the underlying asset’s price and making sure it moves in the direction you anticipated.
If the stock starts to move against you, you might want to consider closing your position before losing too much money. You can buy or sell the options contract before the expiration date.
Alternatively, if the stock is moving in your favour, you might want to hold onto your position and let it run its course. If you do this, keep an eye on the expiration date and close out your position before the options expire.
Close your trade
Once you’ve reached your profit target or the expiration date has passed, it’s time to close out your trade. If you’re still in a profitable position, you can do this by selling the options contract. If you’re no longer in a profitable position, you can close out your trade by buying the options contract.