Options trading allows investors to buy and sell contracts that give the holder the right to buy or sell an underlying asset at a specified price within a certain timeframe. Investors can use options to speculate on the direction of an asset’s price or to hedge against downside risk.
There are two types of options:
- Call options, and
- Put options
Call options give the holder the right to buy an underlying asset at a specified price, while put options give the holder the right to sell an underlying asset at a specified price. Options can be traded through most brokerage accounts on exchanges, or over-the-counter (OTC).
Options trading is a versatile strategy that can be used to speculate on the direction of an asset’s price, generate additional portfolio income, or hedge against downside risk. For example, investors who are bullish on an asset can use call options to buy the asset at a lower price than its future potential. Similarly, investors who are bearish on an asset can use put options to sell the asset at a higher price than it would trade for in the open market.
Options can also be used to hedge downside risk. For example, an investor who owns a stock may use options to hedge against the risk of the stock declining in value. By buying put options, the investor can protect their downside risk.
Many will say that trading options is risky. However, the risks are similar to trading stocks. Investors should consider trading options only on underlying securities they’d like to own while considering the probabilities of a profitable outcome.
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