Learning To Use Options In Trading?
BY CHRISTINE BIRKNER
Published 4/20/2009
Using options and their ability to establish positions with a known risk is a good idea, but there is a catch-22. Beginner and less capitalized traders can benefit from options, but understanding them requires a more in-depth knowledge of markets and volatility than held by many beginners. Options actually can create greater risk if employed incorrectly, so education is key.
An option gives its holder the right, but not the obligation, to buy or sell the underlying asset at a specified price on or before its expiration date. There are two types of options: a call, which gives the holder the right to buy the option, and a put, which gives its holder the right to sell the option. A call is in-the-money when its strike price is less than the underlying price, at-the-money when the strike price equals the price of the underlying and out-of-the-money when the strike price is greater than the underlying. The reverse is true for puts. When you buy an option, your level of loss is limited to the option?s price, or premium. When you sell an option, your risk of loss is unlimited.
One primary use for options is risk management.? ?The most popular hedging position involves purchasing a put to protect a long futures or equity position. This allows traders to maintain their initial position in the underlying while still protecting themselves against significant downside exposure,? says Mark Longo of The Options Insider.com.