Trading Differences Between Options Trading and Stock Trading
There are several differences between trading stocks and trading options. Understanding these discrepancies can make the difference between making money and losing money in the options market, so it's a good idea to have a grasp of them before putting money in an options trade.
An option is a contract that gives the buyer of the option the right, but not the obligation to buy or sell an asset at a predetermined price on or before a predetermined price. A call option gives the individual the right to buy the asset, while a put option gives the right to sell the asset.
Stocks sell at a wide variety of prices, but options only sell at predetermined prices, which are known as the strike price. These strike prices are the agreed-upon purchase or sale prices and are fixed amounts that are set according to the value of the underlying asset. Stocks between $5 and $25 have strike prices in increments of $2.50. Stocks between $25 and $200 have strike prices in increments of $5. Stocks that sell for more than $200 have strike prices in increments of $10.
Stocks sell in individual shares; a person could buy any number of shares they desired. Options aren't dealt in individual shares; they are sold as contracts. Each contract controls 100 shares of the stock in question. If someone had five contracts they would control 500 shares of stock.
Stocks last forever, or until the company ceases to do business. Options, however, have a shelf life and require the holder to take action. Options expire on the close of the market on Friday, at which time all unredeemed options become void.
An option premium is made up of two components: the time value and the intrinsic value. Most experienced traders won't pay more for time value than intrinsic value for any option expiring in three months or less.
Buying a call gives a person the right to buy the stock, while buying a put gives a person the right to sell the stock. Selling a call gives the person the obligation to sell the stock, while selling a put gives a person the obligation to buy the stock.
