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If you trade, you may have heard of options. Trading options carries high risk and has many disadvantages for beginners and even seasoned traders. Therefore, it is wise to be cautious if you are considering options trading. An option is a contract between two parties giving the taker or buyer the right, but not the obligation, to buy or sell shares at a specific price on or before a specific date. To have this right, the taker pays a premium to the writer or seller of the contract. There are two types of options available: call options and put options. Call options give the taker the right but not the obligation to buy the shares at a specific price on or before a specific date. The put options give the taker the right but not the obligation to sell the shares at a specific price on or before a specific date. The taker of a put is only required to deliver the underlying shares if they exercise option. There are a few advantages in option trading: Put options allow you to hedge against a possible fall in the price of the shares you hold. You can consider taking it out as insurance against a loss in the share price. By taking a call option, the purchase price for the shares is locked in. This gives the call option holder until the expiry date to decide whether he or she will or will not buy the shares. This is also applicable to the taker; he or she has to decide whether or not to sell the shares before the deadline. The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them. If you expect the market to rise, you may want to buy call options, and if you are expecting a fall in the market, you may decide to buy put options. This means that you can sell the option prior to the expiry date to take a profit or limit a loss. Options also allow you to build a diversified portfolio for a lower initial outlay than purchasing shares directly. The income generation for options can get you profits over dividends by writing call options against your shares. By writing an option, you receive the option premium up front. While you get to keep the option premium, it is possible that you could be exercised against and have to deliver your shares to the taker at the exercise price. This strategy uses stock bought on margin. By combining different options, or stocks with options, you can create a wide range of strategies. You can earn extra income by writing options against shares you already own or are purchasing. This is one of the simplest and most rewarding strategies. Using options gives you time to decide. Taking a call option can give you time to decide if you want to buy shares. You pay the premium, which is only a fraction of the price of the underlying shares. The option then locks in a buying price for the shares if you decide to exercise. You then have until the expiry date of the option to decide if you want to buy the shares. This is the same as to the put option. Keep in mind that, same as any other trades do not trade what you cannot afford to lose.
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