Published -July 13th, 2023 @ 9:25 AM (GMT+2)

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What is Option Trading?
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‍Options trading involves dealing with contracts that provide the holder with the right, not the obligation, to buy or sell a specific amount of an underlying asset at a predetermined price before a set date. These contracts can be bought through brokerage investment accounts.

Options trading is like getting a ticket to buy or sell something at a specific price by a certain date. But here's the catch: you don't have to use that ticket if you don't want to.

Option trading aims to add more power to your investment portfolio. They can give you extra income, protection and even increase your investment power. Think of options like insurance for your investments. If the market goes down, options can limit how much you lose, just like car insurance helps when you have an accident.

• Underlying stock: This is the specific stock the option is tied to.
• Strike price: The price at which the option lets you buy the stock.
• Premium: The price tag of the option, whether you're buying or selling.
• Expiration: The date when the option ends.
• Options contract: Options are usually sold in bundles, where each bundle equals 100 shares of the stock.

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How Options work?
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‍Options trading works by predicting future price events of an asset. The more probable an event is, the more costly an option for that event becomes. For example, the value of a 'call' option (an agreement that allows you to buy an asset later) rises when the asset's price increases.

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The closer it is to the expiry date of an option, the less it's worth. This is due to the diminishing chances of a price move as time passes, making an option a 'wasting' asset. As a result, an option for a more extended period is worth more than that for a shorter period.

• Call options: let you make money when an asset's price rises above a certain point, known as the break-even price. You can then sell the option (which is also called closing your position) and pocket the difference between what you originally paid and the new price. Or, you can choose to buy the actual asset at the agreed price, known as the strike price.

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• Put options: You make money when the asset's price drops below the break-even level. You can sell your option (closing your position) and collect the difference between what you paid and the current price. Or, you can sell the actual asset at the agreed strike price.

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With options trading, you can speculate on whether the price of an asset will go up or down, by how much, and by when. You can earn a profit by selling the option (closing your position) once the asset's price has exceeded (for call options) or fallen below (for put options) the break-even level. If the price moves in the opposite direction, you can just let the option expire, and your losses will equal the amount you paid for the option.

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Options vs Stock

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Stocks represent ownership in a company and can be bought and sold on a stock exchange. They have an indefinite lifespan and their value is tied to the performance of the underlying business. If a company does well, the stock generally rises, and if it performs poorly, the stock tends to fall. 

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On the other hand, options are contracts that give the holder the right to Buy (call option) or Sell (put option) a stock at a predetermined price within a specified time frame. Options are traded on public exchanges and have a fixed expiration date. 

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• Call options - benefit from increasing stock prices, as their value rises when the stock price goes up.
• Put options - profit from declining stock prices, as their value increases when the stock price falls. 

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In summary, stocks represent ownership in a company and their value depends on the company's performance, while options are contracts that grant the right to buy or sell stocks at a specific price within a set time period.
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Options Risks 

Options trading, a high-stakes investment strategy, involves buying and selling contracts linked to underlying assets like stocks or commodities. Although it promises high returns and leverages the investment, it also introduces substantial risks. The foremost risk is the degree of exposure to potential losses, magnified due to the leverage of options. 

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Volatility, or price fluctuations, also affects an option's price. When volatility increases, there's uncertainty, leading to potentially bigger price swings. This can either push the price of an option up or down.

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Liquidity risk  -  is inherent in options trading. Investors may need help finding buyers or sellers at crucial times or face diminishing contract values as expiration nears. Mispricing is another peril. Priced through complex calculations, options contracts can sometimes be incorrectly valued, leading to surprising losses. The speculative nature of the pricing process can cause unexpected price swings.

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Counterparty risk -  the threat that the other party will default on their obligations. To mitigate this, it's advised to deal only with reputable, regulated brokers or exchanges. Investors must understand these risks and have the resources to manage potential losses. They should also gain proficiency in options pricing to avoid miscalculations and sudden failures.

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Conclusion:

In conclusion, options trading offers a variety of strategies for generating income, speculating on price movements, and hedging risk.
Options trading can effectively maximize investment potential and add protection to your portfolio. However, this high-stakes strategy also brings substantial risks including exposure to potential losses, price volatility, liquidity risks, mispricing, and counterparty default. Therefore, it's crucial for investors to understand these complexities, deal only with reputable, regulated brokers, and become proficient in options pricing to manage potential losses.

MEXEM provides sophisticated options trading tools globally, featuring robust, award-winning platforms accessible via desktop, mobile, and the web. You can engage in options trading across more than 30 market centres worldwide. These platforms deliver extensive market data, enable position tracking, and support concurrent trading of various asset classes and products on one integrated screen.

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The information on mexem.com is for general informational purposes only. It should not be regarded as investment advice. Investing in stocks involves risk. A stock's past performance is not a reliable indicator of its future performance. Always consult a financial advisor or trusted sources before making any investment decisions

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