Option Trading..Only for the Informed

Option trading is not for the uninformed, but it is for anyone interested in adding an investment with special qualities to portfolios. These qualities include the ability to protect stock investment portfolios form unexpected market price changes and the ability to leverage the investment by paying the option premium. But to tell you that options trading is simple or risk free would be untruthful.

The Options Industry Council (OIC) is a great place to begin reading about the basics of options. The commodity exchanges also offer important information for traders new to the buying of options on futures contracts. For stock and commodity trades, the following are some of the main exchanges selling stock or commodity options that you will want to check out.

• American Stock Exchange (AMEX)
• Chicago Board Options Exchange (CBOE)
• Chicago Mercantile Exchange (CME)
• Boston Options Exchange (BOE)
• Nasdaq OMX
• New York Mercantile Exchange (NYME)
• Intercontinental Exchange (ICE)

There are others but these are some of the oldest and largest in the world. Each of the exchanges has account rules and all have established certain standards for options trading. For example, according to the OIC, a stock is eligible for options trading only if it is listed on the NYSE, AMEX or Nasdaq and has had a price that is $3.00 or higher for most of its trading days. There also has to be at least 7 million outstanding shares and 2,000 shareholders.

Futures contracts were first traded in 1865, but option trading on futures didn’t come into existence until as late as 1982. The National Futures Association is the first to admit that futures trading is speculative investing. There are several types of future markets. These markets are where the pricing on commodities begin. When you read about wholesale prices, it means the base price for corn or soybeans or even gold have been established through futures contracts.

Following are the major categories for option trading:

• Stock options
• Stock index futures
• Commodities futures
• Bond futures
• Foreign currency futures
• Interest rate futures

When you decide to begin option trading, it will be necessary to choose a broker and open an account. There are different types of brokers. For example, a full service broker will not only assist with transactions but will do research and even make trade suggestions. Of course the commission rates will be higher for a full service broker than for a discount broker who provides limited services. But today you can also trade directly online through an exchange with the exchange itself serving as the broker. Stockbrokers must be licensed by the National Association of Securities Dealers. Futures brokers must be members of the National Futures Association and registered with the Commodity Futures Trading Commission.

When you are ready to do option trading, the first step is to make sure you understand exactly what you are buying and how much it is going to cost you. In the world of options that can get complex. There are premiums, commissions, and transaction fees to consider in addition to strike price. You need to understand how to calculate the option break-even price before you can determine a fair price for the transaction.

It is possible to open either a cash account (Type 1) or a margin account (Type 2). A margin account is more difficult to qualify for because, in effect, you are buying options using credit in addition to a certain percentage of cash. The Federal Reserve has established limits on how much margin is allowed on a transaction.

Though no one likes to say it out loud, you should not begin option trading unless you have money you can afford to lose. On the other hand, all investments have an element of risk so in that sense option trading is not any different from other financial investments.

Related posts:

• “Borrowed” Stock Short Sellers Include in Options Trading
• Your Option for Trading Stock
• Shorting Stocks and Risk
• Going for Profits with Futures Option Trading
• Futures and Options… the Optional Investment Future
• Fast Paced World of Commodity Option Trading
• Choosing Options for Your Investment Portfolio
• Learning About the Options Trade
• Option – The Concept of Balance
• Types of Options