Option trading provides many advantages over other investment vehicles. Leverage, limited risk, insurance, profiting in bear markets, each way betting or market going nowhere are only a few. But let's look at a couple:. One thing to note before we go on is that the buyer of an options contract pays an amount, known as the premium, to the option seller. An option seller is also known as the writer of the option. The option premium is simply the amount paid for the option - but there is more about this under the Pricing link.

When you buy an option contract from an option seller, you aren't actually buying anything - no asset is actually transferred until the buyer chooses to exercise. It is just an agreement where the buyer has the option to decide if the transfer is to take place.

But the option contracts value is determined by the underlying asset - Microsoft Shares as an example. Options give the buyer the right to buy a number of shares of the underlying instrument from the option seller. The amount of shares or futures contracts to buy is determined by;. The contract multiplier also called contract size is different for most classes of options and is determined by each exchange. In the US, the contract size for options on shares is This means that every 1 option contract gives buyer the right to buy shares from the option seller.

So, if you buy 10 IBM option contracts, it means that you have the right to buy 1, IBM shares at expiration if the price is right 10 x In other countries such as Australia, the contract multiplier for stock options is 1,, which means the every option contract you buy entitles you to 1, underlying share contracts. So pay attention to the contract specs before you begin option trading.

This also means that the price of the option is also multiplied by the contract multiplier. This is a crucial concept to understand. So, even though the shares only went up 3. Penny Stocks are companies that have very low share prices. You can buy some stocks for as little as 10c. For this reason penny stock trading is becoming very lucrative for online speculators. They can still trade the stocks outright as well as making massive returns if they are correct about their view on market direction.

The only drawback with penny stocks is trying to pick which stocks to buy. They have a free trial, so you can see for yourself whether penny stock trading is for you or not.

Penny stocks can be risky though - there's a reason why they're so cheap, nobody wants them!

So, be careful to act on the right information. One of the biggest advantages option trading has over outright stock trading is to be able to take a view on market direction with limited risk while at the same time having unlimited profit potential.

This is because option buyers have the right, not the obligation, to exercise the contract for the underlying at the exercise price. Let me give you an illustration. Remember our initial example of Peter buying a Microsoft Call option? Here are the details of that trade provided with the appropriate jargon;. This means we must consider this in our profit estimate.

Therefore we add the option premium to the strike price to determine our break even point. If we exercise our right and take delivery of the shares, this means that we will have to pay the full amount for the shares. So, the number of option contracts bought multiplied by the contract size multiplied by the exercise price. If you are planning to hold onto option contracts until expiry and take delivery, make sure you have the cash! Think about what happens as the underlying price continues to rise.

You continue to make more and more money once the stock price has exceeded the strike price. What have we lost though? A lot less than if the stock plummeted and we lost our entire investment. Can you see now how this type of strategy gives you the best of both worlds - both limiting your risk and at the same time leaving you open to make unlimited profit if the market rallies? Not all option strategies have this payoff benefit. Only if you are buying options can you limit your risk.

For option sellers, this is the reverse - they have unlimited risk with limited profit potential. So, why would anybody want to sell options? Because options are a decaying asset, which you can read more about under the Time Decay section. Another reason investors may use options is for portfolio insurance. One example of this is called a Protective Put.

You can read more about option trading strategies under the Strategies link. Once you sell the option back to the market your position is now flat and you have no option nor obligation. You only have the obligation to sell stock when your position in a call option is "short". If I purchased a call option and decided to sell it back to the market for a profit, am I now obligated to sell stock to whomever bought back the call option from me should they choose to exercise it?

Hi Kenny, Yes, you can exercise the option as it is in-the-money. In your above example, If Underlying: Hi Mike, The strike price won't change: If the stock price increases, however, and you would like to profit without exercising then you can simply close out the position by selling the same number of contracts back to the market - just like you would do if you were long a stock position and wanted to close it by selling. Hi Peter, If I will use TDA for options trading and wants to buy a call option but doesn't want to exercise it due to limited fund, what should i do to sell it and make profit if the strike price increases?

These are terms that are often used in platforms offered by brokers to clients who trade electronically.

Options contract specifications - ASX

Hi Mike, No need to be sorry, it's a fair question. Contracts x Contract Size or Multiplier x Market Price. The standard contract size for options on stocks is Im still confused and sorry for asking these questions. Example money in your account: How much money do you need in order to buy 10 calls? Yes, you can certainly sell it back in the market to close it out.

The price, however, will be USD 20 the market price not the strike price of USD Suppose the strike price is Usd10 and maket price is Usd20, could i sell the optiton at Usd10 to other buyers directly? Hi Ning, No, the contract size is standard and set by the exchange. If you don't have the funds to exercise you can simply close out the position prior to expiration to realize your profits.

Hi Peter, since you mentioned the contract size is shares, could i buy only 50 shares when executing the call option contact supposedly i am short of money? If an option is trading at its' intrinsic value then it will be in-the-money and have a delta of 1. That is the only reason I can see for buying an in-the-money option close to expiration: Peter, What's the incentive on buying a contract at it's intrinsic value?

I mean if a contract is about to expire within a few days, a person can: Why do people buy contracts close to the expiration when they could just buy shares of that stock out right? I initially couldn't figure out why EVERYONE doesn't trade options. Anyways just wanted to say thanks for clearing that up for me and hope this helps other new investors. Hi, the information is very useful.

Why Trade Options?

Thank you for this. I have one question: Do I have to own certain stock before I can buy the contract of Put Option for that stock? Hi Patrick, yes, you can simply sell out of the options prior to expiration if you do not want to exercise and take delivery of the stock. By the time the option reaches expiration the option will be trading at its' intrinsic value and hence there shouldn't be any difference in profits between the two scenarios.

I know this question has been asked several times, but I'm not sure I've read a definitive enough answer to feel comfortable pulling the trigger on a call option buy. I want to purchase a boatload of call option contracts but will not have the cash to exercise the option at expiration. Do I just sell prior to expiration to avoid this? And is there any difference in profit between the two scenarios selling option before expiration and exercising option at expiration?

At that point you can walk away with no more obligation. Your sell order on the option just closes the original long purchase position. Much like if you buy shares and then go and sell shares.

After the sell you will have 0 shares. You would only have exercise risk if you sold the option without having an open long position first. When you sell back the option, another participant the buyer will be on the other side.

Let me know if anything is unclear. Peter I have a bunch of questions that I just can't seem to find a clear answer for. Can I just walk away after that with my profit? Doesn't my sale of the call option that I previously bought count as a closing transfer and its not possible for someone to exercise the call option I just sold and force me to deliver? I believe that just selling a call option is a type of short position so you would have the obligation to deliver if the buyer exercised, but it's not a short position when I sell an option that I already bought instead of just selling a call option outright?

I just want to make sure that if I sell a call option that I previously bought for a profit, I have no obligations whatsoever and can just leave the market with my profit. Since I wouldn't have enough money to buy hundreds or thousands of shares outright, but I have enough to buy options and I believe many people sell options that they couln't cover if exercised.

And i'm also unclear on whether my call option gets bought by someone or just ceases to exist and the open interest will decrease? Yes, you will make a loss on the shares as the buyer won't exercise unless the stock is higher than the strike price. However, it doesn't mean that you will have a total loss as you still have the premium received when you sold the option, which you will offset against the loss on the shares. If it's a call option then you will have to sell the stock at the strike price to the option buyer.

If it's a call option then you will have to buy the stock at the strike price from the option buyer. No, you don't have to buy it back - you can leave the position open until the expiration date. If the call option is out-of-the money then, yes, you will just keep the premium as your profit.

However, if the option is in-the-money then you will be required to sell the stock at the strike price but still keeping the premium already received. Hi, If I sell a call option, do I have to buy it back in the market? Or can I wait utill it is expired and have the premium as my profit? There is only 1 reason to BUY options: If you are thinking of making unlimited profits from options, then you have to very accurate about where the price of the underlying security will move, which is difficult; unless you are a real EXPERT There is only 1 reason to SELL options: It's value depreciates over time.

The above line is critical, when it comes to making option trading strategies. What would my profit be if I decided to exercise the option? Hi Chris, difficult to know for sure as it depends on the delta of both options and also how the implied volatility of the options changes as the stock has rallied. You could exercise, sure, but only if you want to continue being long the stock. If you just want to profit from the option you can sell it before it expires in the open market without having to take delivery of the stock.

Now tell me if the following sentence is correct please. Another question from the last example: Thanks and sorry if this is explained somewhere else and I overlooked it. Hope this makes sense.

What do I need to do to minimize the lost? Can I sell back the option right on the expiration date? Is anyone will buy the option with the expiration date on the same day? What happen if on the expiration date I don't have enough money to exercise the contract? Either that or the trader might be selling the call together with another option as part of an option strategy. Is it because the price of the option would exceed the difference between the stock and the strike prices?

Hi Dan, Yes, the proceeds from the sale go back into your account. If the proceeds from the sale were more than what you spent on the option, then it is a profit. I have an call option on a stock thats 20 share. Hi Doug, Yep, you can get in and out of your position any time you like up until expiration.

About your second question However, most optionable stocks have option market makers who are there to provide liquidity so you won't have a hard time getting out of a position Hello I have a couple questions. Can I just sell the option before the expiration date? And if I can, I see there isn't much volume in options so is it easy to get in and out like high volume stocks?

However, each contract represents shares of the underlying asset. Hello Admin, i have doubts on this: Yep, you can sell back at any time provided there is a market there - i.

You may not necessarily "cash in" as the price of the option at day 40 may be less than your original purchase price. Sorry if this was asked before but am I right? If yes, does that hold for a put contract too? Hi Paul, That's right. You can trade in and out of options before expiration and take advantage of the leverage options provide, however, if you decide to exercise and take delivery of the underlying asset then you will need enough in your account to cover purchasing the stock.

I have never traded options but would like to start. My question is this. If you purchase on option and decide to excercise the option, do you have to purchase the shares of stock in the open market? If so, it seems like you would have to have quite a bit of money in your trading account.

Am I missing something? Hi Yash, Yes, if you're long a call option that is in the money and allow it to expire, your broker will automatically exercise your option into shares provided you have the funds in your account.

In case of fall in stock price its possible to just sit on the contract and let it expire and lose just the premium, is the applicable in the event of a climb in stock price as well or are you obliged to buy the shares beyond the expiry date.

Hi Alvin, You won't be able to exercise without sufficient funds available. If you wanted to profit from a call option right before expiration you would just sell back the contract in the option market to realize the profit. But let's look at a couple: Leverage One thing to note before we go on is that the buyer of an options contract pays an amount, known as the premium, to the option seller.

The amount of shares or futures contracts to buy is determined by; The number of option contracts, multiplied by The contract multiplier The contract multiplier also called contract size is different for most classes of options and is determined by each exchange. Options What are Options? Where are Options Traded? Option Types Option Style Option Value Volatility Time Decay In-The-Money?

Payoff Diagrams Put Call Parity Weekly Options Delta Hedging Options Asset Types Index Option Volatility Option Currency Options Stock Options.

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