What Is Options Trading?

what is options trading what is an option what are call options what are put options reasons to trade options what is options trading

Options are powerful financial tools used by investors and traders. They have potential to increase leverage, provide income, and modify market risks. Some investors are surprised to find out that when options are employed in conjunction with other investments they can lessen overall market risk.

Traders employ options in many different variations. Some are drawn to the one-sided and limited risk of buying options. Others operate as market-makers, optimising profits by facilitating investors’ option trading. The calculus underlying options is complex, but any individual who can add, subtract and calculate a percentage return can make use of option potential to increase overall market returns.

What is an option?

An option is an agreement amongst two parties. There is a huge variety of options, which all involve a seller of an option (the writer) granting certain rights to the buyer of an option (the taker) in return for a payment (the premium).

What are call options?

A call option gives the taker the right, without obligation, to buy a specified trading instrument at a specified price, on or before a specified date. The writer of a share option must deliver the underlying shares, at the specified price, if the taker decides to exercise their option (to buy).
The writer receives a payment, known as a premium, for granting the taker this right.

What are put options?

A put option gives the taker the right, without obligation, to sell a specified trading instrument at a specified price, on or before a specified date. The writer of a share option must buy the underlying shares, at the specified price, if the taker decides to exercise their option (to sell).
The writer receives a payment, known as a premium, for granting the taker this right.

Risks to trading options

The risks involved when trading options depends on the strategy employed. Option strategies may involve a single option series, or a number of option series, both puts and calls.

One little understood aspect of options is that when they are used alongside other investments they can reduce overall market risk. At the opposite end of the risk spectrum, writers of options can experience large or even theoretically infinite risk. Its crucial that users are aware of the risks of any specific strategy before continuing.

Reasons to trade options


  • Earn income from your share portfolio – Investors can generate income from their portfolio by writing call options against their stock holdings. This is known as a covered call, or buy-write, and is one of the most commonly used strategies by investors.
  • Protect share holdings – investors worried about the near term prospects for a stock holding can protect against a share price drop by taking a put option in that stock.
  • Protect portfolios – investors concerned about the market outlook can negate portfolio losses by taking put option over the index. If the market drops, the put option’s value increases as the portfolio declines. The success of this strategy depends on a number of factors, including the composition of the individual portfolio.
  • Lock-in attractive prices – where investors find an opportunity in a stock, but don’t have sufficient capital to buy immediately, they can secure a purchase price by taking a call option now and exercising the right to purchase in the future.
  • Buy stocks cheaper – investors can reduce share purchase expenses by writing put options in stock they want to purchase. If the share price is under the option strike price at expiry, the investor buys the stock at the strike price and keeps the premium for the initial put option write. A risk is that the stock rises quickly, and the put isn’t exercised, meaning the investor won’t buy the shares. But in this situation the investor still keeps the initial premium. This is commonly called a cash-covered put write.


  • Trade more opportunities– Option prices react to more factors than just the movement in the underlying share or index. Changes in volatility, interest rates and dividends can have an impact on the value of options. This means traders can select positions that reflect their views on more instruments and markets.
  • Increase capital efficiency through leverage – traders make use of the leverage options provide. As an example, a trader who anticipates a stock may rise from the current price of $20 could invest just $1 in a call option. A stock rise of $2 could represent a $1 rise in the option. The return on capital invested in the stock is 10%, in the option it is 100%. This leverage comes with higher risk. If the stock falls $1 and stays lower, the loss on the share position is 5%, while the trader could lose 100% on their option.
  • Tailor market exposures – there are numerous option configurations and strategies available. A deep understanding of the accepted risks opens up strategies such as collars, straddles, strangles, vertical and horizontal spreads, butterflies and condors, among many others. Traders can profit from a stock or index rising, falling, or remaining neutral. Some option strategies are quite reactive to changes in volatility, interest rates, and/or changes in the volume and timing of dividends. Traders can construct positions that give more precise exposures to a possible event.
  • Limit position risk – the taker of an option can only lose the original premium. Traders seize on this characteristic in many ways. For example investing a small percentage of the value of a basket of stocks in put options, lowering the overall risk of the traders position. A trader who thinks Bank A is cheap relative to Bank B could take call options in Bank A, and put options in Bank B, minimising the risk of the trade to the premium spent. The possibilities when marrying options, and other asset positions, is restricted only by a trader’s curiosity.

What Is Options Trading Conclusion

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To reinforce to What Is Options Trading? readers that there's numerous Option configurations.