How to Trade Options: A Beginner’s Guide to the Risks (and Rewards)
On the other hand, shares of AMZN can be too pricey for most traders. Traders then cash in on the difference, or simply walk away. One important note is that options all expire, generally within 30 days. As mentioned above, trading options provides traders with numerous benefits. By buying the right to purchase or sell a stock at a specified price, traders are invested in the stock with limited risk. And because of this lower capital requirement and no obligation to actually purchase the asset, options also allow for better diversification than simply buying stocks outright.
Additionally, options allow for a more conservative approach to trading thanks to the low capital investment. However, there are numerous options trading strategies that traders can utilize to match their trading style. Options give traders leverage, letting you hedge your account to protect yourself.
As with any trading, options trading has risks.
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How Options Pricing Works
Instead, our system considers things like how recent a review is and if the reviewer bought the item on Amazon. The answer to these questions is not easy, unless you analyse the details of the agreement thoroughly. I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here!
In fact, this deal has many faces to it.
2 Options Trading Strategies Beginners Can Use | The Motley Fool
Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months. Now, with the increase in the land price, do you think Ajay will call off the deal? This means Ajay now enjoys the right to buy a piece of land at Rs , when in the open market the same land is selling at a much higher value of — Rs 10,00, Ajay is making a steal here.
He would go ahead and demand that Venu to sell him the land. Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs , agreement fees from Ajay 6 months earlier.
Options Trading: A Beginner's Guide to Make Money By Trading Options With Practical Strategies
Another way to look at this is — For an initial cash commitment of Rs , Ajay is now making 4 times the money! Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. It turns out that the highway project was just a rumour, and nothing really is expected to come out of the whole thing. People are disappointed and hence there is a sudden rush to sell out the land.
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As a result, the price of the land goes down to Rs , So what do you think Ajay will do now? It does not make sense to buy the land, hence he would walk away from the deal. Here is the math that explains why it does not make sense to buy the land —. Remember the sale price is fixed at Rs ,, 6 months ago.
If Ajay has to buy the land he has to shell out Rs , and Rs , paid towards agreement fees. Which means he is in effect paying Rs , to buy a piece of land worth just Rs , Clearly, this would not make sense to Ajay, since he has the right to call off the deal, he would simply walk away from it and would not buy the land.
However do note, as per the agreement Ajay has to let go of Rs ,, which Venu gets to pocket.
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For whatever reasons after 6 months the price stays at Rs , and does not really change. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land.
Why you may ask, well here is the math —. It does not make sense to buy a piece of land at Rs , when it is worth Rs , Since Ajay has already committed Rs 1 lakh, he could still buy the land, but ends up paying Rs 1 lakh extra in this process. For this reason, Ajay will call off the deal and in the process let go of the agreement fee of Rs , which Venu obviously pockets. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work! But, let us not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction.
Agreed Ajay would lose Rs 1 lakh, but the best part is that Ajay knows his maximum loss is Rs 1 lakh.