Investing offers you the opportunity to make gains with your capital. You can complete this by utilizing various methods. Buying stocks or ETFs is a popular strategy, but there’s also a way to diversify your portfolio by participating in options trading.

What Are Options?

Purchasing a stock or ETF allows you to own shares in a public company or slew of companies. According to the experts at Money Morning, “The fastest way to build wealth is to both invest in stocks and trade options. Options let you yield bigger – and faster – profits than you’d get from only buying and selling stocks, and do so while paying just a fraction of the price of shares.” If you decide to buy an option, which is also known as a contract, it allows you to purchase or sell an ETF or stock at a specific price during a particular period. The value of an option is derived by where the underlying instrument is trading at a specific time. While there are several different strategies available to utilize when investing in options, you can only use calls or puts to accomplish your financial goals.

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Call Options

Purchasing a call option or contract gives you the ability to acquire a specific number of shares of an underlying instrument at a particular strike price during a specific period. You can use this right if you’d like but can also let the option expire or sell the option before expiration. For example, if you purchase one call option, you’re usually able to buy 100 shares at a specific price before the contract expires. Placing this type of trade means you’re expecting the underlying instrument to increase in price. You’ll pay a premium, which is like a fee that allows you to purchase shares if you’d like.

Put Options

Deciding to buy a put option allows you to sell a specific number of shares of an underlying instrument during a particular period. It’s the opposite of a call option. It is used when you believe an underlying instrument, which might be a security or commodity, is overpriced and likely to fall in value. Like a call option, buying one put option is usually equal to 100 shares of the underlying instrument. If the underlying instrument is a stock, buying a put option will likely allow you to sell 100 shares of the stock at a specific strike price. You’ll pay a premium, or fee, to complete this type of transaction.

What Are the Risks?

One of the most significant risks of options trading is time decay. Investing in options is typically done for short-term price movement, which may take place within a few days, weeks or months, depending on the period chosen for the option. You are required to pick the time to make your purchase and decide if you’re going to exercise the option. You don’t have to worry about this with long-term investing.

How Do You Identify Good Stocks for Options?

Finding good stocks for options requires you to formulate an investment objective. Are you expecting a specific stock to go up or down shortly? This price action might be due to upcoming earnings. For example, if you think a company’s profits might be better than expected, buying a call option may be the right choice. Checking the historical volatility of the underlying instrument can also be helpful.

There are several different ways to utilize options in your portfolio. This introduction touches just the bare minimum of the opportunities provided when you use this asset class.