The set price is called the strike price, and the time frame is known as the expiration date.
Types of stock option
1. Call Options: A call option gives the buyer the right to purchase a specific stock at a predetermined price within a certain time frame. The buyer of a call option hopes that the stock’s price will increase so that they can buy it at the lower strike price and sell it at the higher market price to make a profit.
2. Put Options: A put option gives the buyer the right to sell a specific stock at a predetermined price within a certain time frame. The buyer of a put option hopes that the stock’s price will decrease so that they can sell it at the higher strike price and then buy it at the lower market price to make a profit.
Risks of trading stock options
1. Limited Time: Options have an expiration date, which means that traders must be right about the direction of the stock’s price movement and the timing of that movement. If the price of the stock doesn’t move in the right direction within the expiration date, the option may expire worthless, and the trader could lose their entire investment.
2. Volatility: Stock options prices are influenced by the volatility of the underlying stock. If the stock’s price experiences large price swings, it can be difficult to predict the direction of the price movement, which can increase the risk of losses.
3. Leverage: Stock options provide traders with leverage, meaning that a small amount of money can control a larger amount of stock. While this can lead to large profits if the trade goes in the right direction, it can also lead to significant losses if the trade goes against the trader.
4. Complexity: Stock options can be complex financial instruments, and traders must understand the terminology and concepts associated with options trading to be successful. Misunderstandings or making mistakes can result in significant losses.
5. Counterparty Risk: Options contracts are created and traded through brokerage firms, which act as intermediaries between the buyer and seller. If the brokerage firm goes bankrupt or fails to honor its obligations, the trader may not be able to execute their trades or may lose their investment.
Key point
A stock option is a financial contract that gives the buyer the right, but not the obligation, to buy or sell a specific stock at a set price within a certain time frame.
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