Options are the most versatile and complex trading instrument ever invented
How to start trading options – another post or tutorial, if you like, about trading is in front of you, published by Traders Paradise.
In just a few minutes, you will find all you need to know about trading options:
- What Are Options
- Why Use Options
- How Options Work
- What Are Types of Options
- How to Buy Options
- How to Sell & Write Options
- How to Choose the Right Options Trading Strategy
- Options Spreads
- Benefits of Trading Options
Options are the most versatile and complex trading instrument ever invented, so we decided to write about it.
This post is for for everyone who wants to understand the world of options. You will be introduced with fundamental concepts of options trading and ends with some basic strategies and you’ll be able to use them immediately.
This tutorial is intended for both, beginner and advanced interested in learning about the ins and outs of options trading.
No prior knowledge was taken for granted.
Every single word here came from serious research, personal experience and experience of professional traders.
In this post, we are providing you a general outlook of options.
We will explain how they function. Also, when is the right time to trade them.
And how they can be traded.
In the tutorial Trading options, you will find their advantages and disadvantages.
Also, there you can find the variety of option styles and a summary at some of the strategies that can be used to trade options successfully.
Our intention is to give you the basic knowledge about what options are and how to use them.
Options have a reputation for being difficult to understand.
But they are brilliant tools for both hedging speculation when you properly use them.
And in this article, we will tell you all about them.
Everyone can find something interesting in Trading options tutorial.
Both beginners as much as advanced traders or anyone who wants to learn more about trading options.
The purpose of this article is to provide an introduction to some of the basic equity option strategies available to option and/or stock investors.
Exchange-traded options have many benefits.
The flexibility, leverage, the limited risk for buyers employing these strategies, and contract performance.
They allow you to participate in price movements without committing a large number of funds needed to buy the stock outright.
Also, they can be used to hedge a stock position, to acquire or sell stock at a purchase price more favorable than the current market price.
Or, in the case of writing (selling) options, to earn a premium income.
Options give you options.
You’re not just limited to buying, selling or staying out of the market.
With options, you can tailor your position to your own financial situation, stock market outlook and risk tolerance.
When most people think of investment, they think of buying stocks in the stock market. Most of them completely misunderstand terms like options trading.
One of the more common investment strategies is buying stocks and holding on to them in order to make long-term gains.
Yes, that is the reasonable way to invest if you have some idea about which stocks you should buy or use some broker’s help to provide an advice or guidance.
Every advanced trader would tell you that investing with options is all about customization.
Yes, you can get high rewards but also the loss.
Choices are plenty.
Starting to trade options isn’t easy because there is a big potential for expensive mistakes.
In this post Trading options, you will find the real core of this versatile way to invest.
Trading options are known as a buy and hold strategy.
It can help you boost your wealth in the long run, but it doesn’t provide much in short-term gains. These days more popular are immediate returns.
Frankly, options trading is more for the DIY (do-it-yourself) investors.
Options traders are self-directed investors.
They never work directly with a financial advisor to help them to manage their options trading portfolio.
So, what is an option?
An option is a contract to buy or sell a stock, usually 100 shares of the stock per contract, at a pre-negotiated price and by a certain date.
The power of options lies in their versatility, and their ability to interact with traditional assets such as individual stocks.
They enable you to adapt or adjust your position according to many market situations that may arise.
Options can be used as an effective hedge against a declining stock market to limit downside losses.
They can be put to use for speculative purposes or to be exceedingly conservative, as you want.
Using options is, therefore, best described as part of a larger strategy of investing.
So, let’s start!
What Are Options?
Options are the type of derivative financial instruments (security), contracts that grant the right but not the obligation, to buy or sale of the underlying asset to which they relate at the price indicated in the option contract until a certain date.
Can be issued on the basis of other financial instruments, financial non-material or real property, but behind each option must stand the asset to which the option is related.
Options are the type of derivative financial instruments (security).
There are historical findings that confirm their use during the Antiquity period. The first options were used in ancient Greece to speculate on the olive harvest.
But the fact that trade options have prospered in the last 50 years.
The most significant event that enabled popularization of trading options was the establishment of the first arranged stock exchange option in Chicago in the year 1973 under the name of the Chicago Board of Options. Since then, a number of stock options have been established in the US and around the world.
Options are a very useful financial instrument because of their characteristics.
They offer investors a range of options.
They can be used as an instrument for speculation, for the protection and management of market risks (hedging) or for arbitration.
In this way to any investor in accordance with its goal of trading, current market position, expectations, and preferences, according to the risk and personal preferences, options can create the desired position.
The right to buy is called a call option and the right to sell is a put option.
Once again, options are the type of derivative.
People a bit familiar with derivatives may not see an evident difference between this definition and what a future or forward contract does.
To clarify this thing.
Futures or forwards confer both the right and obligation to buy or sell at some point in the future.
For example, somebody short a futures contract for corn is obliged to deliver real corn to a buyer unless they close out their positions before expiration.
An options contract does not carry the same obligation, which is precisely why it is called an “option.”
Once again, options are a great way to add flexibility to your portfolio since they can be used for both hedging risk and speculation.
The benefits that options offer are high profitability, risk limitation, financial leverage, flexibility and the ability to stay on the market without the need to own a marketable asset.
Unfortunately, the general public knows little about these instruments and part of the investors are not able to trade options because of ignorance about their use.
The options, like all derivative instruments, are complex in nature, and we have to know their capabilities and limitations so that we can effectively use them for the stated purposes.
Trading with options is also specific and differs from trading with conventional financial instruments, that’s why the investor needs to be well aware of trading rules with options.
The brief review of options basics:
1) An option is a contract which brings to its holder the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) shares of the underlying security at a specified price (the strike price) on or before a given date (expiration day).
After this given date, the option ceases to exist.
The seller of an option is, in turn, obligated to sell (in the case a call) or buy (in the case of a put) the shares to (or from) the buyer of the option at the specified price upon the buyer’s request.
Option contracts usually represent 100 shares of the underlying stock.
2) Strike prices or exercise prices are the stated price per share for which the underlying security may be purchased in the case of a call or sold in the case of a put, by the option holder upon exercise of the option contract.
The strike price, a fixed specification of an option contract, should not be confused with the premium, the price at which the contract trades, which fluctuates daily.
Equity option strike prices are listed in increments of 21/2, 5, or 10 points, depending on their price level.
3) Regulation to an option contract size or strike price may be created to account for stock splits, mergers or other corporate actions.
Overall, at any given time a particular option can be bought with one of four expiration dates.
4) Option holders do not enjoy the rights due to stockholders. They don’t have voting rights, regular cash or special dividends, etc. A call holder must exercise the option and take ownership of underlying shares to be eligible for these rights.
5) Sellers and buyers in the exchange markets, where all trading is conducted in the competitive manner of an auction market, set option prices.
Market Dictionary and Jargon In Trading Options
LONG – Describes a position (in stock and/or options) in which you have purchased and own that security in your brokerage account.
Let us explain, if you have bought the right to buy 100 shares of stock, and are holding that right in your account, you are long a call contract.
If you have bought the right to sell 100 shares of stock, and are holding that right in your account, you are long a put contract.
If you have purchased 1,000 shares of stock and are holding that stock in your brokerage account, or elsewhere, you are long 1,000 shares of stock.
When you are long an option contract: you have the right to exercise that option at any time prior to its expiration and your potential loss is limited to the amount you paid for the options contract.
SHORT – Describes a position in trading options in which you have written a contract (sold one that you did not own).
In return, you now have the obligations in terms of that option contract. If the owner exercises the option, you have an obligation to meet.
If you have sold the right to buy 100 shares of stock to someone else, you are short a call contract.
If you have sold the right to sell 100 shares of stock to someone else, you are short a put contract. When you write an option contract you are creating it.
The writer collects and keeps the premium received from its initial sale. When you are short, you are the writer of an option contract and you can be assigned an exercise notice at any time during the life of the option contract.
All option writers should be informed that assignment prior to expiration is a distinct possibility and your potential loss on a short call is theoretically unlimited.
This means the risk of loss is limited by the fact that the stock cannot fall below zero in price.
Although technically limited, this potential loss could still be very large if the underlying stock declines in price.
OPEN – The opening transaction is what adds to, or creates a new trading position.
It can be a purchase or a sale. Opening purchase – a transaction in which the purchaser’s intention is to create or increase a long position in a given series of options. Opening sale – a transaction in which the seller’s intention is to create or increase a short position in a given series of options.
CLOSE – A closing transaction is reducing or eliminating an existing position by an offsetting purchase or sale.
The closing purchase is a transaction in which the purchaser’s intention is to reduce or eliminate a short position in a series of options.
This transaction is known as “covering” a short position.
A closing sale is a transaction in which the seller’s intention is to lessen or eliminate a long position in a series of options.
LEVERAGE AND RISK – Options can provide leverage which means an option buyer can pay a small premium for market exposure in relation to the contract value (usually 100 shares of the underlying stock).
The investor may have a large percentage of gains from comparatively small, favorable percentage moves in the underlying equity.
Leverage also has downside consequences. If the underlying stock price does not rise or fall as anticipated, leverage can increase the investment’s percentage loss.
Options offer their owners a predetermined, set risk.
But, if the owner’s options expire with no value, this loss can be the entire amount of the premium paid for the option. An uncovered option writer may have unlimited risk.
THE STRIKE PRICE or EXERCISE PRICE
In trading, options determine whether that contract is “in the money”, “at the money”, or “out of the money”. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in-the-money because the holder of this call has the right to buy the stock at a price which is less than the price he would have to pay to buy the stock in the stock market. If the strike price equals the current market price, the option is said to be at-the-money.
This is the amount by which an option, call or put, is in-the-money at any given moment. By definition, an at-the-money or out-of-the-money option has no intrinsic value; the time value is the total option premium. This does not mean that you can get these options at no cost.
The amount by which an option’s total premium exceeds intrinsic value is called the time value portion of the premium. It is the time value portion of an option’s premium that is affected by fluctuations in volatility, dividend amounts, interest rates, the motions in time.
There are various factors that give options value and affecting the premium at which they are traded.
Altogether, these factors determine time value.
WHY USE OPTIONS
One of the largest benefits of using options is leverage.
Trading options give the buyer the right, but not the obligation to buy a stock at a fixed price for the specified length of time.
Buying an option provides you exposure to price movement in the underlying stock. For a given percentage change in the underlying price, the change in option price in percentage terms is much greater.
Frankly, if you trade options, you can enjoy the rewards of leverage, with only the predetermined and ponderable risk of losing the premium, or the price paid for the option.
The other biggest advantage is the limited risk.
Options trading has the ability to have perspective on the market direction with restricted risk and at the same time having unlimited profit potential. This is because option buyers have the right, not the obligation, to exercise the contract for the underlying at the exercise price.
If the price is not right at the time of expiration, the buyer will lose his right and simply let the contract expire worthless.
Insurance is another reason.
Investors may use options for portfolio insurance. Options contracts can give the investor a method to protect his downside risk in the event of a stock market crash.
Speculation is one of the greatest advantages.
Options are the world in which you will not be restricted to making a gain only when the market is successful. Due to the adaptability of options, you can produce a profit even when the market goes downward or even sideways.
If you consider speculation as betting on the movement of a security.
That’s why options have the reputation of being insecure in which big profits are made or lost. When you are buying an option you must correctly forecast whether a stock will go up or down if you want to succeed.
Also, you will have to forecast how much the price can fluctuate also the length of time it will take for this process.
Don’t forget commissions too.
The mixture of these factors means the odds are arranged against you.
Another function of options is hedging as an insurance policy.
Options are used to ensure your investments against a downswing. Critics of options comment that if you are not sure of your stock picks, and you need a hedge, you should reconsider making the investment. Vice versa, there is no apprehension that hedging strategies can be helpful, particularly for large institutions. Even the individual investor can benefit. By using options, you will be able to confine your downside while enjoying the full upside in a cost-effective way.
Like everywhere, in trading options, we can find some adverse effects.
Leverage is a double-edged sword. If the common stock had remained at e.g. $100 through the life of the contract or worse, dropped below the $100 strike level by the expiration date, the option would have declined to zero and the loss would have been 100 percent.
The cost of trading options includes commissions and the bid price is higher on a percentage basis than the underlying stock itself.
In order to be a successful options trader, you must make an effort to educate yourself about how options work and different trading strategies because one of the characteristics of trading options is its complexity.
Options, by their nature, are time sensitive. If you do not exercise a contract before its expiration date, the option will become worthless.
HOW OPTIONS WORK
Options are the most versatile trading instrument ever invented.
Options cost less than stock. They provide high leverage access to trading that can notably limit the risk of a trade or provide a nice income.
Option buyers have rights and option sellers have obligations.
Option buyers have the right, but not the obligation, to buy (call) or sell (put) the underlying stock (or a futures contract) at a specified price until the 3rd Friday of their expiration month.
There are two kinds of options: calls and puts.
Call options give you the right to buy the underlying asset.
Put options give you the right to sell the underlying asset. It is important to be informed with both.
Not only informed. It is crucial to be familiar with the essence of both. Every strategy depends on the understanding of these two kinds of options.
In trading options the risk is limited to the price of the option, that’s why there is no margin if you want to buy an option.
Option sellers receive a credit in their account for selling an option and get to keep this amount if the option expires worthless. But, option sellers have an obligation to buy (put) or sell (call) the underlying instrument if their option is exercised by an assigned option holder.
That’s why selling an option requires a healthy margin.
The simplest way to use options is to buy or sell options and hold the same position to maturities of the option when the option is either executed or not without exercising rights from the option.
The option can be used independently (uncovered position) or in combination with the asset to which it relates (covered position).
It becomes much more complex when merger more the same or different options, whereby the basic terms of the option contract can be varied, which are: the size of the contract, the market price of the option (premium), the executive price and the maturities, to which the investor creates the most favorable position with regard to market movements.
Different combination options are called trading strategies with options.
The use of long and short positions in options and underlying assets is based on six basic strategies that can be subsequently combined in complex strategies, such as long position and short position in assets, long and short position in the call option and long and short position in the offer option.
Thanks to these six basic positions, the investor can apply these strategies: basic simple and covered strategies, complex strategies involving different types of ranges, combinations such as straddle, strangles, guts, and synthetic strategies or advanced delta neutral, proportionate trading and combining combinations, ranges, etc.
Which strategy the investor will apply accurately depends on its characteristics of risk, income, timing of payment (and bound with the value of the initial payment), the complexity suits the goals of trading, market position, expectations regarding market trends, risk and profit relationship and the skills of the investor, as well as the market availability of options.
Options, when bought, are done so at debit to the buyer.
Options, when sold, are done so by giving a credit to the seller.
Options are available in several strike prices representing the price of the underlying instrument.
The cost of an option is referred to as the option premium.
The price reflects a variety of factors including the current price of the underlying asset, the strike price of the option, the time remaining until expiration, and volatility.
Options are good for a specified period of time, after which they expire and you lose your right to buy or sell the underlying instrument at the specified price.
Options are not available on every stock.
There are approximately 2,200 stocks with tradable options.
Each stock option represents 100 shares of a company’s stock.
WHAT ARE THE TYPES OF OPTIONS?
The main difference is between call and put option.
Also, there is an important difference between European and American style options. These options, as well as others where the payoff is calculated similarly, are referred to as “vanilla options”.
Options, where the payoff is calculated differently, are categorized as “exotic options”. Exotic options can pose challenging problems in valuation and hedging.
First: the difference between call and put:
A Call Option gives the buyer the right, but not the obligation to buy the underlying security at the exercise price, at or within a specified time.
A Put Option gives the buyer the right, but not the obligation to sell the underlying security at the exercise price, at or within a specified time.
These are definitions. But what does this exactly mean?
Investors buy calls when they think the share price of the basic security will rise or sell a call if they think it will fall.
Call options provide the holder the right (but not the obligation) to buy an underlying asset at a specified price (called strike price), for a specified period of time.
If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless.
Selling an option is also called to as ”writing” an option.
What is CALL OPTION?
A call option is an option contract in which the holder (buyer) has the right (but not the obligation) to buy a specified quantity of a security at a specified price (strike price) within a fixed period of time (until its expiration).
For the writer (seller) of a call option, it represents an obligation to sell the underlying security at the strike price if the option is exercised. The call option writer is paid a premium for taking on the risk associated with the obligation.
For stock options, each contract covers 100 shares.
A call option gives the holder the right, but not the obligation, to purchase 100 shares of a particular underlying stock at a specified strike price on the option’s expiration date.
The stock, bond, or commodity is known as the underlying asset.
For example, a single call option contract may give a holder the right to buy 100 shares of some stock or commodity or bond at $100 up until the expiry date in 2 months.
There are many expiration dates and strike prices for traders to choose from.
As the value of the stock goes up, the price of the option contract goes up, and vice versa.
The call option buyer may hold the contract until the expiration date, at which point they can take delivery of the 100 shares of stock or sell the options contract at any point before the expiration date at the market price of the contract at that time.
The market price of the call option is called the premium.
It is the price paid for the rights that the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid. This is called the maximum loss.
If the underlying price is over the strike price at expiry, the profit is the current stock price, minus the strike price and the premium. This is then multiplied by how many shares the option buyer controls.
Another example, if a certain asset is trading at $220 at expiry, the strike price is $200, and the options cost the buyer $4, the profit is $220 – ($200 +$4) = $16.
If the buyer bought one contract that equates to $1600 ($16 x 100 shares), or $3,200 if they bought two contracts ($16 x 200). If it expiry below $200, then the option owner loses $400 ($4 x 100 shares) for each contract the trader bought.
What is PUT OPTION?
A put is an option contract giving the buyer the right, but not the obligation, to sell a specified amount of an underlying asset at a set price within a specified time.
The owner of a put option believes the underlying asset will drop below the exercise price before the expiration date. The exercise price is the price the underlying asset must reach for the put option contract to hold value.
Each option contract includes 100 shares.
Consider the investor who purchases one put option contract on XY company for $200.
The exercise price of the shares is $20, and the current XY share price is $24. This put option contract has given the investor the right, but not the obligation, to sell 100 shares of XY at $20.
If XY shares drop to $16, the investor’s put option is in the money and the owner can close the option position by selling the contract on the open market.
On the other hand, the owner can purchase 100 shares of XY at the existing market price of $16, and then exercise the contract to sell the shares for $20.
Ignore commissions, the profit for this position is $400, or 100x($20 – $16).
Keep in mind that the buyer of the options paid $200 premium for the put, giving the right to sell shares at the exercise price.
And trader’s total profit is $400 – $200 = $200.
A call option gives the holder the right, but not the obligation, to buy a stock at a certain price in the future.
When investors buy a call, they expect the value of the underlying asset to go up.
A put is the opposite.
When investors purchase a put, they expect the underlying asset to decline in price.
The investors then profit by selling the put option at a profit or exercising the option.
Some investors can also write a put option for another investor to buy.
If investors write a put contract, they don’t expect the stock’s price to drop below the exercise price.
HOW TO BUY OPTIONS
Buying and selling stock options isn’t just new territory for many investors, it’s a whole new language, new world.
Regardless, there are historical findings that confirm their use during the Antiquity period as we said before in Chapter 1.
You might suppose these options markets are another superfine financial instrument that Wall Street gurus created for their own dishonest purposes, but you would be wrong.
Actually, options contracts did not originate on Wall Street at all.
These instruments exist for thousands of years – long before they began officially trading in 1973 under the name of Chicago Board of Options.
Since you have a better understanding of what options are (calls and puts) let’s look at how to buy a call option in a more detailed explanation.
At first, to buy a call you must first recognize the stock you think is going up and find the stock’s ticker image.
image source: screenshot from Yahoo finance
When you get a quote on stock on most sites you may click on a link for that stock options chain which lists every actively traded call and put option that exists for that stock.
Let’s go step by step:
1) Identify the stock that you think is going to go up in price
2) Review stock Option Chain
3) Select the Expiration Month
4) Select the Strike Price
5) Determine if the market price of the call option seems reasonable
You must realize that not all stocks have options that trade on them. Only the most popular stocks have options.
You cannot always buy a call with the strike price that you want for an option.
Strike prices are generally at intervals of $5 e.g. $30, $35, $40. From time to time, you can find $34,5 or $32,5 available for popular stocks.
You will not always find the expiration month you are looking for on the option for which you want to buy a call. Most of all, you will see the expiration months for the closest two months.
Then every 3 months thereafter.
Surprisingly, if you find the option that you want to buy a call on, you still need to make sure it has enough volume trading on it to provide liquidity so that you can sell it if you decide to.
The most options are infrequently traded and therefore have a higher bid/ask spread.
To buy a call you have to understand what the option prices mean and you have to find one that is reasonably priced.
If trading is at $22,5 a share in September and you are looking to buy a call of the November $32 call option, the call option price is regulated like a stock, fully on a supply and demand basis.
If the price of the call option is $0.5 then not many people are expecting to rise above $60; and if the price of that call option is $4,000 then you know that a lot of people are expecting that option to rise above $60.
The most important things to understand when you want to buy a call is that option prices are the function of the price of the underlying stock, the price, period left to expiration and volatility of stock itself.
The volatility and the expected volatility of the stock are keeping traders in different opinions and hence drives prices.
Many genuine investors and traders wake up in the morning and sneak a peek at the stock futures to anticipate where the market will open in comparing to the previous day’s close.
The main characteristics of call options
- The security on which to buy call options.
Suppose you think XY Company stock is going to rise over a specific period of time. You can consider buying XY call options.
The number of options contracts to buy.
Each options contract controls 100 shares of the underlying stock. Buying 2 call options contracts, for example, grants the owner the right, but not the obligation, to buy 200 shares (2 x 100 = 200)
The strike price.
The price at which the owner of options can buy the underlying security when the option is exercised. For example, XY 100 call options allow the owner the right to buy the stock at $60, regardless of what the current market price is. In this case, $60 is the strike price (this is known as the exercise price too).
The trade amount that can be supported.
Means the maximum amount of money you want to use to buy call options.
The expiration month.
Options do not last forever. They have an expiration date.
If the stock closes below the strike price and a call option has not been exercised by the expiration date, it expires worthless. So the trader has no longer the right to buy the underlying asset.
Hence, the trader loses the premium paid for the option.
Most stocks have options contracts that last up to nine months.
Traditional options contracts typically expire on the third Friday of each month.
The price to pay for the options.
When you buy the stock for the stock price, you buy options for what’s known as the premium. Premium is the price to buy options. In 100 XY call options example, the premium might be $4 per contract.
It means the total cost of buying one XY 100 call option contract would be $400 ($4 premium per contract x 100 shares that the options control x 1 contract = $400).
If the premium were $6 per contract, instead of $4, the total cost of buying 2 contracts would be $1,200 ($6 per contract x 100 shares that the options control x 2 total contracts = $1,200).
The type of order.
Options prices are constantly changing, like stocks. So, you may choose the type of trading order with which to purchase some options contract.
There are several types of orders, including market, limit, stop-loss, stop-limit, trailing-stop-loss, and trailing-stop-limit.
HOW TO SELL & WRITE OPTIONS
When we are talking about writing a put or call option we are speaking about an investment contract in which a fee is paid for the right to buy or sell shares at a future date. Put and call options for stocks are typically sold in lots of 100 shares.
A little review of history. The origins of writing an option date back to ancient times. Don’t think it is something new.
Aristotle, the Greek philosopher, recorded an early example of options trading in his ”Politics”. The philosopher and mathematician Thales of Miletus studied astronomy as a way to predict olive harvests for his region.
Thales believed there would be a coming bountiful olive harvest, but did not have the money to buy his own olive presses.
So, instead of paying a fee for the right to access the olive presses of others.
Do you see? This was the first options contract.
So, writing a call option means that you are selling a call option. If you sell a call (also known as a “short call”) then you are obliged to sell stock at the strike price.
Typically, a call is sold against long stock.
When you buy some option $400 call option that you have the right to buy 100 shares of some company at $400, and maybe you asked yourself the question “who exactly am I buying it from?”
To have the right to buy the stock at the strike price, somebody has had to take the other side of that transaction and agreed to give you the right to buy it.
The ones that take the opposite side of the call option buyer are the “call option sellers.”
And sometimes they are known as “call option writers”.
When you BUY call options, you bought it from someone.
That means that someone is giving you the rights to buy the underlying stock at the strike price by selling you that option.
The act of CREATING and SELLING that call options contract to you by that person is the act of WRITING a call option.
In execution, this means opening a call options position using the SELL TO OPEN order.
When you do that, you create a new call options contract for trading in the options market and that is known as “Write” a call options contract because you are exactly “writing it up”.
Selling options, whether Calls or Puts, is a popular trading technique to increase the returns on the portfolio.
Selling Premium can prove successful when performed on a selective basis. But, if you don’t follow some specific guidelines, your long-term prospect of profitability is doubtful.
Selling options for Income can be debatable because you don’t know are you making money with your options trading. When you take a look in your overall portfolio it can be difficult to measure each transaction success.
But in this environment is yield-seeking, and selling options is a strategy designed to generate current income. Selling options, whether Calls or Puts, is a popular trading technique to increase the returns on the portfolio.
Selling Premium can prove successful when performed on a selective basis. But, if you don’t follow some specific guidelines, your long-term prospect of profitability is doubtful.
Selling options for Income can be debatable.
Because you don’t know are you making money with your options trading. When you take a look in your overall portfolio it can be difficult to measure each transaction success.
But in this environment is yield-seeking, and selling options is a strategy designed to generate current income.
Selling options is a bit more complex than buying options and can involve extra risk. If sold options expire worthlessly, the seller gets to keep the money received for selling them.
Let us be clear with more details.
There are two types of call option selling.
If you bought a call option and the price has gone up you can always just sell the call on the open market. This type of transaction is called a “Sell to Close“ transaction because you are selling a position that you currently have.
If you do not currently own the call option, but rather you are creating a new option contract and selling someone the right to buy the stock from you, then this is called “Sell to Open“, “Writing an Option“, or sometimes just “Selling an Option.”
Writing or selling a call option
That is when you give the buyer of the call option the right to buy a stock from you at a certain price by a certain date.
Simpler, the seller (also known as the writer) of the call option can be forced to sell a stock at the strike price.
The seller of the call receives the premium that the buyer of the call option pays.
If the seller of the call owns the underlying stock, then it is called “writing a covered call.”
If the seller of the call does NOT own the underlying stock, then it is called “writing a naked call.”
A covered call enables you to own a stock with unlimited downside risk and collect a premium for the call you sold.
When you sell a covered call you are actually selling a synthetic put.
If you are not comfy selling naked puts, then you should not be comfy selling a covered call.
It is exactly the same as selling a put.
If you are comfortable with the covered call, then there are numerous factors to analyze when entering any options position.
Now, it is convenient to look at what factors can make a trade more likely to be profitable than another.
At the top of any list is liquidity or the percentage of the difference between the bid and ask. If you are giving away too great a percentage to the market-makers or algorithms, then the costs of entering the transaction are too high.
You should look to trade an options contract that has a bid/ask spread of less than 1.5%. Always consider that the more you give away to the bid/ask spread, not only entering but exiting the transaction.
Well, this may prove difficult at times, but it isn’t easy to make money.
Besides this, all trade evaluations must consider the cost of commissions. While all of these costs make profitable trading that much more difficult, they must be included in your analysis.
You should consider the relative strength index of the underlying, extreme conditions tend to provide more interesting trading opportunities.
A seller is obligated to buy or sell an underlying security at a specified strike price if the buyer chooses to exercise the option.
There must be a seller for every option buyer.
There are several resolutions that must be made before selling options:
1) What security to sell options on
2) The type of option (call or put)
3) The type of order (market, limit, stop-loss, stop-limit, trailing-stop-loss, or trailing-stop-limit)
4) Trade amount that can be supported
5) The number of options to sell
6) The expiration month
When all this information is collected, a trader goes into the brokerage account, select security and go to an options chain.
Once an option has been selected, the trader goes to the options trade ticket and enter a sell to open order to sell options and makes the appropriate selections (the type of option, order type, number of options, and expiration month) to place the order.
Here are the key things you should remember with respect to buying and selling call options.
You buy a call option only when you are bullish about the underlying asset.
Upon expiry, the call option will be profitable only if the underlying has moved over and above the strike price.
Buying a call option is also referred to as ‘Long on a Call Option’ or simply ‘Long Call’. To buy a call option you need to pay a premium to the option writer.
The call option buyer has a limited risk (to the extent of the premium paid) and a potential to make an unlimited profit.
The breakeven point is the point at which the call option buyer neither makes money nor experiences a loss
P&L = Max [0, (Spot Price – Strike Price)] – Premium Paid
Breakeven point = Strike Price + Premium Paid
When you sell a call option (also called option writing) only when you believe that upon expiry, the underlying asset will not increase beyond the strike price.
Selling a call option is also called ‘Shorting a call option’ or simply ‘Short Call’.
When you sell a call option you receive the premium amount. The profit of an option seller is restricted to the premium he receives, however his loss is potentially unlimited.
The breakdown point is the point at which the call option seller gives up all the premium he has made, which means he is neither making money nor is losing money.
Since short option position carries unlimited risk, he is required to deposit margin. Margins in case of short options are similar to futures margin.
P&L = Premium – Max [0, (Spot Price – Strike Price)]
Breakdown point = Strike Price + Premium Received
When you are bullish on a stock you can either buy the stock in the spot, buy its futures, or buy a call option.
When you are bearish on a stock you can either sell the stock in the spot (although on an intraday basis), short futures, or short a call option.
The calculation of the intrinsic value for a call option is standard, it does not change based on whether you are an option buyer/ seller.
You sell a call option when you are bearish on a stock.
When you sell a call option you receive a premium.
Selling a call option requires you to deposit a margin.
When you sell a call option your profit is limited to the extent of the premium you receive and your loss can potentially be unlimited.
Nothing more, nothing less.
HOW TO CHOOSE THE RIGHT OPTION TRADING STRATEGY
Option trading strategies have fancy names like “bear spreads”, “condors” and “butterflies”.
But option strategies have complex mathematical relationships driving their value.
The jargon and mathematics of options trading all too often scare away the average investor from exploring the power of options.
Even if you are not planning to invest using options in the near future this book will be of interest to you as you get a brief look at the fascinating potential of options.
The hardest part of planning each individual trade, probably, is choosing which strategy to use.
This is exceptionally true if you are relatively new to trading options, or if you don’t have the understanding of the different strategies that can be used.
Even experienced traders can sometimes struggle to decide what the best strategy to use is.
It’s fair to say that the more options trading experience you gain, the easier that decisions become.
We have to say, there’s actually no such thing as the right strategy.
There are many factors to take into view because a strategy that might be suitable in one situation could be totally inappropriate for a different set of financial position.
A lot depends on the individual because what is right for one trader might not be right for another. We would never claim that we are able to tell you exactly which strategy you should be used for any situation.
But we can tell you how you can make that decision yourself.
In this article ”Trading Options’‘, we’ll show you a number of the considerations you need to be taking into account.
If you are new to trading options, then we suggest you to spend some time working out the best strategy to use each and every time you enter a new position.
As you become more experienced, you will have a better idea about how each strategy works and the process of making a decision should become less complicated for you.
What is Your Outlook?
Options traders have four potential outlooks to consider:
- The bullish, such trader is expecting the price to rise;
- The bearish, trader who is expecting the price to fall;
- The neutral, trader who is expecting the price not to move, or at least remain relatively stable and volatile, who is expecting significant swings in price.
If you are more exact in your outlook, it’s much easier to choose a suitable strategy.
For example, if you expected underlying security to increase notably in the price you would know not to use a strategy that returned a profit on a small price increase and didn’t keep generating profits if the price continued to rise.
There are strategies, though, that are particularly suitable for certain outlooks.
Options trading strategies come with varying degrees of complexity. There are very simple, typically those that involve one or two transactions. There are some that are more complicated, requiring three or more transactions.
The complexity of a strategy is definitely something that you need to think about when deciding which one to use.
The more transactions that are required, the more you will pay in broker commissions.
This can have an impact on your potential returns, particularly if you are trading on a small budget.
Complexity of Strategy
Using more complicated strategies can also make it harder to work out what the potential profits and losses of trade are, and what price movements will be best for you.
Deciding about the ideal entry and exit points of a position is a key part of planning a trade. This is generally a lot easier to do when you are using simpler strategies.
The more complicated ones also give you something else, whether to carry out all the required transactions simultaneously, or whether to place each order individually.
Online brokers include functionality that allows you to easily select your strategy, and then the orders that it requires will automatically be executed at the same time.
Options trading strategies come with varying degrees of complexity.
Options Trading Strategies
1) Bull Call Spread
This is one of the most often used options trading strategies there is. It’s relatively simple, demand just two transactions to execute, and perfectly suitable for novices.
It’s used when the outlook is bullish, and the expectation is that an asset will increase a fair amount in price. You use the buy to open order to buy at the money calls based on the relevant underlying security, and then write an equal number of out of the money calls using the sell to open order. This results in a debit spread, as you spend more than you receive.
The basic idea of writing the calls in addition to buying them is to reduce the overall costs of the position. The decision you have to make is what strike price to use for the out of the money contracts you need to write.
The higher the strike price, the more potential profits you can make but the less money you receive to balance the costs of buying at the money calls.
You have to write the contracts with a strike price equal to where you expect the price of the underlying security to move to.
For instance, if you are expecting the underlying security to move from $100 to $110, then you have to write contracts with a strike price of $110. If you feel the underlying security will increase by $3, then you write them with a strike price of $103.
The advantage of using the Bull Call Spread strategy is
You have the chance to make a bigger return on your investment. This is a simple strategy, which appeals to many traders, and you know exactly how much you stand to lose at the point of putting the spread on.
The disadvantages of this strategy
They are limited, maybe that’s why it’s such a popular strategy. There are more commissions to pay than if you were simply buying calls, your profits are limited and if the price of the underlying security rises beyond the strike price of the short call options you won’t make further gains.
2) Bearish Trading Strategies
When you expect underlying security to fall in price, you will want to be using suitable trading strategies – bearish.
New-come traders believe that the best way to generate profits from underlying security falling in price is simply to buy puts, but unfortunately, this isn’t necessarily the case. Buying puts isn’t a brilliant idea if you are expecting a small price reduction in a financial instrument. And you have no protection if the price of that financial instrument doesn’t move or goes up instead.
There are other strategies that you can use to overcome that kind of problems, and many of them offer other advantages.
Purchasing puts is indeed a bearish options trading itself.
And sometimes the right thing to do is to simply buy puts based on an underlying security that you expect to fall in price.
But, this approach is limited in a number of ways.
A single holding of puts could expire worthless if the underlying security doesn’t move at price. That means that the money you spent will be lost and you will make no return.
The negative effect of time decay on holding options contracts means that you’ll need the underlying security to move a certain amount just to break, and even further if you are to generate a profit.
You have to be aware of how some of the downsides can be avoided through the use of alternative strategies.
If you want to take a position on underlying security going down in price but didn’t want to risk too much capital, you could buy puts and also write puts (at a lower strike) to reduce the upfront cost.
Also, this will help you offset some of the risks of time decay. Or you can write calls.
You can even use strategies that return you an initial upfront payment (credit spreads) instead of the debit spreads that have an upfront cost.
Disadvantages of this strategy are limited profit potential, which means that to get an extra benefit (such as limited risk) you have to make a sacrifice (such as limited profit).
Also, you will have to pay more in commissions.
A number of different strategies to choose from are a disadvantage in itself because it takes extra time and effort to decide which is the best one for any particular situation.
3) Arbitrage Strategies
This strategy defines circumstances were price inequalities means that an asset is effectively underpriced in one market and trading at a market price in another.
Arbitrage exists if it’s possible to simultaneously buy an asset and then sell it immediately for a profit.
Such scenarios are popular because they provide the potential for making profits without taking any risk.
But these scenarios are a bit rare.
They are marked by professionals at the big financial institutions.
They come occasionally in the options market though, primarily when an option is mispriced or when accurate put-call parity is not maintained.
4) Synthetic Trading Strategies
Combination of options and stock to emulate other trading strategies are said to be synthetic.
They are used to adjust an existing strategy when the outlook changes without having to make too many additional transactions.
Synthetic trading strategies are essentially an extension of synthetic positions.
A synthetic position is a position that recreates the characteristics of another trading position by using different financial instruments such as an options position that has the same characteristics as holding stock.
The three most commonly used are the synthetic straddle, the synthetic short straddle, and the synthetic covered call.
5) Protective Puts And Protective Calls
Strategies that use options to protect existing profits that have been made, but not realized, from either buying or short selling stock.
When a long stock position or a short stock position has performed well, a trader can use a protective put or a protective call respectively to preserve the profits that already have been made in the event of a reversal.
But also allow continued profitability should the stock continue to move in the right direction.
For instance, you bought a particular stock at $15, and the price then rises to $25.
If you wanted to be able to profit from further price increases, but also safeguard against the price dropping back down, then the protective put will help you do this.
It’s essentially a straightforward hedging technique.
6) Delta Neutral Strategies
Delta is one of the five main Greeks that influence the price of options.
Actually, the most important of these, because it’s a measure of how much the price of an option will change based on the price movements of the underlying security.
They are used to create positions where the delta value is zero, or close to it.
Such positions aren’t affected by small price movements in the underlying security, meaning there’s little directional risk involved.
They are typically used to hedge existing positions or to try and profit from time decay or volatility.
7) Gamma Neutral Strategies
Gamma is another of the Greeks. This is the neutral strategy, designed to create trading positions where the gamma value is zero or very close to zero.
That would mean that the delta value of those positions should remain stable regardless of what happens to the price of the underlying security.
They can be used as reducing the volatility of a position or attempting to profit from changes in implied volatility.
They can also be combined with delta neutral strategies for more stable hedging.
8) Stock Replacement
One of the most commonly used stock replacement strategies involves buying calls instead of buying stock.
It’s actually a very simple strategy, and even complete beginners should have no problem using it.
More advanced traders can also use hedging techniques to further limit the risks and volatility that are involved.
9) Stock Repair
Stock repair is a technique that stock traders can engage, using options, to increase the chances of recovering from being long on a stock that has fallen in price.
It’s possible to break even from a smaller price increase in the stock than would otherwise be possible, without having to commit any more capital if you use this technique correctly.
Stock repair using options is quite simple for use.
10) Married Puts, Fiduciary Calls, and Risk Reversal
The last three!
The married put combines a long stock position with a long put options position on the same stock. It is the same as a protective put but it’s executed differently and is not used for precisely the same reasons. It involves making the two required transactions (buying stocks and writing puts) at the same time and is used primarily to limit the potential risks involved in buying stocks.
The fiduciary call involves buying calls and also investing capital into a risk-free market such as an interest-bearing deposit account. It’s a stock replacement technique but serves a slightly different purpose. Its main function is to effectively reduce the costs involved with buying and exercising calls.
Risk reversal is a phrase that has two meanings in investment terms. It can be used to refer to a strategy involving options that are employed, commonly in commodities trading. It’s a hedging technique used to protect against a drop in price. It’s also used in forex options trading to describe the difference in implied volatility between similar call options and put options.
Options spreads are the basic building blocks of many options trading strategies.
A spread position is entered by buying and selling the equal number of options of the same class on the same underlying security but with different strike prices or expiration dates. The Spread is the bridge between the basic Option strategies and advanced strategies.
In fact, most advanced strategies are composed of the spreads we cover in this book ”Trading Options”.
For the engaged professional, Spreads offer the right mixture of reward and risk.
The three main classes of spreads are:
a) The horizontal spread
Horizontal, calendar spreads or time spreads are created using options of the same underlying security, same strike prices but with different expiration dates.
A horizontal spread is created by writing options contracts of a particular type and buying contract of the same type but with different expiration months.
At first, you have to use a sell to open order to write contracts of a certain type with an expiration date of, for instance, September.
Then you have to use the buy to open order to buy contracts of the same type but with an expiration date of the following April for example.
You can use calls or puts.
You can make the positive return by making more in time decay through the short term options you write than you lose in time decay through the ones you buy.
The longer-term contracts have the benefits of reducing the margin requirement of the short position and offsetting the potential losses should the underlying security involved. The principle of horizontal spreads is based on how time decay affects the value of options contracts.
b) The vertical spread
Vertical spreads, or money spreads, are spreads involving options of the same underlying security, same expiration month, but at different strike prices.
Creating a vertical spread is simple.
You can create one by buying options contracts, using the buy to open order, and selling contracts, using the sell to open order.
The contracts must be of the same type.
The options contracts appear vertically stacked when looking at them on an options chain and that’s why they are called vertically spreads.
This options strategy is when you make a simultaneous purchase and sale of two options of the same type with the same expiration, but different strike prices.
If you buy calls at one strike price and write calls with a different strike price you have to create a vertical spread.
You can also do the same with puts.
c) The diagonal spread
Diagonal spreads are constructed using options of the same underlying security but different strike prices and expiration dates.
They are called diagonal spreads because they are a combination of vertical and horizontal spreads.
Diagonal spreads are composed of similar options contracts.
They must be of the same type and based on the same underlying security, but the contracts have different expiration months and different strike prices.
To create a diagonal spread you need to sell to open order, to write options contracts, and the buy to open order to purchase options contracts.
First, you have to write contracts, and then buy contracts of the same type and on the same underlying security, but with a later expiration date and a different strike price.
You can create them using calls or puts.
They are grouped by the relationships between the strike price and expiration dates of the options involved.
But we also recognize 4 other Spreads – Bull Call, Bear Call, Bull Put and Bear Put. So, let’s go step by step.
What are Bull Call and Bull Put?
When you want to construct a bull call spread, you have to a lower strike price call, and then sell a higher strike price call. The aim is to have the stock rise in price and close upon expiration at a price bigger than or equal to the higher strike.
It makes sense to jump in while it’s low, right?
A vertical spread will have two strike prices with the same expiration month. Call contract with the higher strike price will be worth less than the call contract with the lower strike price, and the net result of this transaction will be a net debit.
Spread strategy such as the ‘Bull Call Spread’ is best implemented when your outlook on the stock/index is ”moderate” and not really ”aggressive”.
It doesn’t guarantee a profit, but it does hedge against your losses.
It’s a complicated trade as you take two positions at the same time but when it works, it can be successful.
Bull call spreads consist of two legs: you write (sell to open) a call at a higher strike price and simultaneously buy (buy to open) a call at a lower strike price.
So you’re writing a call and using the proceeds to purchase a call on the same stock, setting up a bullish position with reduced costs.
Your maximum profit will be the difference between the two strike prices, less the net cost to set up the spread and your maximum loss is the cost to set up the position in the first place.
When you implement a bull call strategy that means: on the same underlying stock, you buy a call option and simultaneously write a call option with a higher strike price, using the same expiration date.
The purchased call leverages your gains on the underlying stock. At the same time, the written call pays the cost of the purchased call and increases your leveraged returns.
But be aware, the bull call spread does this at the cost of your potential upside, which is limited.
Over the time frame of your options, it’s possible for the gains in the underlying stock to eclipse the returns on the spread.
A bull call spread is a type of vertical spread, like any options strategy in which you simultaneously buy and write options of the same type (calls or puts) with the same expiration date, but with a “spread” between the strike prices.
A Bull Put Spread purpose is to profit from the stock that is either stalled or rising. It was conceived to find income-generating options trades that are bullish and have limited downside risks.
Because of its limited risk, a Bull Put Spread is equally safe when learning the basics of stock market investing.
To identify stock for a Bull Put Spread, it is necessary to execute the stock market analysis.
When you find a stock that is range-bound or able to rise, you need to make a trade on the options that will expire in one month or less. At the same time, you should buy a lower strike puts that are $5 below the higher strike price. After that, sell the same number of higher strike puts that expire on the same date.
Remember, both puts should have strike prices that are LOWER than the current stock price.
Your aim should be to earn a 12% net credit from the trade.
For instance, if the difference or spread, between the two strike prices, is $10.00, you want to realize a net credit of at least $1.20 for the trade. If the stock is steady or moves up, the profit you earn is the net credit amount.
Your risk is the difference between the strike prices minus the net credit for the complete trade.
A Bull Put Spread is relatively safe and has the potential for a good return. This is a perfect opportunity for beginner stock market investing.
When the investor adopts this technique, technical analysis tools and abilities will limit the success of this strategy.
Adding the usage of the Bull Put Spread to your techniques will increase your success in trading.
What are Bear Call and Bear Put?
A Bear Call Spread is a strategy employed when the market is extremely volatile and moderately bearish.
The sale of a call spread (a “short call spread” or “bear call spread” position) is a bearish options strategy that consists of simultaneously selling a call and buying a call at a higher strike price.
The strategy builds on a naked short call by purchasing a call at a higher strike to reduce the risk of the position.
Because of the unpredictable movements in a bear market, an investor will, in many cases, look to make moves that are profitable, but that hold low risk. The Bear Call Spread, also known as the Bear Credit Spread, is a technique that successful traders use in erratic circumstances.
A trader sells a call option at one strike price and buys a call on the same asset which is further out-of-the-money (at a higher strike price). In most cases, both options will have the same expiration date.
The profit and loss strategy for a Bear Call Spread is almost the same to a Bear Put Spread.
However with this technique. The trader immediately receives a net premium when establishing the position.
In a Bear Put Spread, the premium is paid when the position is established. Because of this difference, the investor already has money in hand at the inception of the Bear Call Spread.
Using Bear Call Spread means lower risk than the Bear Put Spread, but the profit potential is reduced.
In a Bear Call Spread, the risk is minimized because the investor purchases lower priced calls that are protected if the price goes up notably.
Vice versa, in a Bear Call Spread, the profit potential is limited to the premium collected for the calls sold, less the cost of the premium paid for the calls that were purchased.
This strategy is used in a bearish market, unlike the Bull Call Spread, which is employed when the market has become bullish.
Bear Call Spread is a perfect example of successful trading. When an investor, through stock market analysis, realizes the existence of a bear market, it is vitally important to modify the stock investing system.
Then the bear market typically moves a trader into a more conservative approach of minimizing risks and finding trades that are less risky but still profitable.
A Bear Call Spread is a perfect example of such a conservative move to find profits.
The Bear Put Spread method, also known as Vertical Bear Puts too, is used by successful traders to realize profits when the market is looking to the money of the investor.
The profit and loss strategy for a Bear Put Spread is very similar to a Bear Call Spread.
A trader will buy a put option on a particular stock that is out-of-the-money and will sell an out-of-the-money put on the same stock.
For this method, both options should have the same expiration date. With a Bear Put Spread, the trader does not immediately realize the net premium when establishing the position as is the case with a Bear Call Spread.
In a Bear Put Spread, the investor must wait until the expiration date to see any profit.
The trader doesn’t have money in hand, so the profit potential is greater with a Bear Put Spread.
The Bear Put Spread is riskier than a Bear Call Spread, but the opportunity for profit is bigger than implanting the call spread.
In a Bear Put Spread, if the stock price increases above the in-the-money, higher, put option strike price at the expiration date, then the investor has a maximum loss potential of the net debit.
Vice versa, the maximum profit possibility involved in a Bear Put Spread occurs when the stock decreases below the out-of-the-money, lower, put option strike price.
In a Bear Call Spread, the maximum profit potential is limited to the premium collected for the calls sold, minus the cost of the premium paid for the calls that were bought.
Both strategies can be utilized in a bearish market. But you should be careful about understanding the risk-reward ratios for each strategy.
BENEFITS OF TRADING OPTIONS
Ability to control the same amount of shares with less money, which means that the maximum loss is lower, is a benefit of buying a call option versus purchasing 100 shares.
The advantage is that you know the maximum risk of the trade at the beginning.
The maximum risk of buying $4,000 worth of shares is, in theory, the entire $4,000 because the stock could go to zero.
In our example, the maximum risk of buying one call options contract (right to control 100 shares) is $400.
The risk of buying the call options (our example), as opposed to buying the stock, is that you could lose the $400.
If the stock’s price drops and you are not able to exercise the call options to buy the stock, you would not own the shares as you wanted to.
But, if you simply bought the stock at $60 per share, you would own it right away, which is maybe better for some traders, than having to wait on exercising the call options to potentially own the shares.
This is a disadvantage.
And the other is that they lose value over time because there is an expiration date. Stocks do not have an expiration date. And the owner of stock receives dividends, while the owners of call options do not receive dividends.
Options are very often seen as fast moving, fast money trades.
Surely options can be cruel plays.
They’re volatile, forced and speculative. Options have made fortunes and ruined them for many traders. Options are sharp tools, and you have to know how to use them without abusing them. Options have, well, rogue reputation, and their pragmatic side is frequently overlooked.
Try to think about options as an investor, not as a trader, and you will see that they give you more options. Some simple strategies offer limited risk and a large upside.
At the same time, conservative investors can rely on stock options as a source of income and a protective hedge in market declines. Options are not vehicles just for the purpose of speculating. They actually have far better uses for purposes of income generation and risk reduction.
But a universal benefit of trading options is that you can trade them in a retirement account (this one has proven to be a lucrative and appealing way to grow and hedge your portfolio over time).
Options allow for better diversification by a minor capital outlay versus buying stocks.
Options are cheaper than purchasing the stock outright. They allow more markets to be traded at the given time and create more trading and investing opportunities.
The options markets have proven to be highly efficient and liquid.
Options are built on stocks and these two can be mutually beneficial when used together correctly. The point is that you can sell options to generate income on stocks that you already own. Options offer a logical and conservative trading approach.
Option trading frightens a lot of traders off, no matter if they are young, old, advanced, beginners.
The investment seems complex, too volatile to handle without outside guidance or big research. But contrary to widespread belief, options succeed where other sectors of the market tend to fail.
Take for example the fact that that volatility itself can be profitable. Or fact that you don’t have to exercise an option to profit from it. These outside forces are ready and able to work in your benefit with the proper allocation and strategy.
Options trading are a multi-faceted, highly lucrative asset and it can be used in every investor’s portfolio.
You can trade options from every single point on the Planet, having just an internet connection. And options allow for both sides of the route to be traded. That, in turn, increases the total number of trends to be utilized and potential returns.
There is more leverage, more ability to hedge account to safeguard, the list seems to go on and on.
Can’t you see, words like “risky” or “dangerous” have been wrongly connected to options thanks to some financial media and prominent figures in the market.
It is very important for every single investor to get both sides of the story before making a decision about the value of options.
Options are the most trusty form of the hedge which makes them safer than stocks. When an investor buys stocks, a stop-loss order is frequently placed to protect the position.
The stop order is designed to stop losses below a preset price identified by the investor. The problem with these orders lies in the nature of the order itself.
A stop order is executed when the stock trades at or below the limit as indicated in the order.
When you buy a put option for protection, you don’t have suffered the catastrophic loss. Unlike stop-loss orders, options do not shut down when the market closes. They give you insurance 24 hours a day, seven days a week.
That stop orders can’t do. This is why options are considered a dependable form of hedging.
Less money to make almost the same profit, and you have a higher percentage return.
When they pay off, that’s what options typically offer to investors. The major advantage of options is they offer more investment choices.
Options are a very flexible tool.
There are many ways to use options to recreate other positions so-called synthetics.
Trading options allow the investor to trade the market’s “third dimension,” and if you wish, no direction.
Options allow the investor to trade not only stock movements but also the passage of time and movements in volatility. Most stocks don’t have large moves. Only a few stocks actually move significantly, and they do it not often.
Personal ability to take advantage of stagnation could turn out to be the factor deciding whether your financial goals are reached or they remain simply a dream.
Only options offer the strategic alternatives necessary to profit in every type of market.
Options trading entails significant risk and is not appropriate for all investors.
Certain complex options strategies carry additional risk.
Views and opinions expressed in this tutorial are based on personal experiences of WYT author.
These comments you should not view as a recommendation for or against any particular security or trading strategy.
Because views and opinions are subject to changes due to markets and other conditions.
Options are the extreme high-risk investment tool.
Frankly, the vast majority think like that.
Why trading options are considered a high risk?
Most investors lose money in options. Statistics show that over 80% of all options traders lose money.
Why is this so?
Because the odds are united against winning from the start.
First, the direction of price movement has to be correctly analyzed. This procedure alone is a major barrier for most of the investors.
Further, the magnitude of the price move must have correctly calculation. Unfortunately, this is another procedure that the average investor doesn’t want to polish more.
All the way to the high gloss!
And, being correct to the time element is the unaccounted aspect of most option analysis.
The combination of these three crucial factors makes it extremely difficult to access an options trade correctly.
And to add more pain in your life, a premium is built into the option price.
This premium reflects the speculative fervor of the market participants who think prices will move in their direction.
The highly leveraged method of participating in the move creates a parasitic premium that is added to the true value of the option.
Like many successful investors, options traders have a clear understanding of their financial goals.
Hence, the way you approach and think about money will have a direct impact on how you trade options.
The best thing you can do before you fund your account and start trading options is to clearly define your investing goals.
Don’t waste your money!
About the author
Guy Avtalyon is a data researcher that uses statistic models and unsupervised machine learning algorithms to determine trends in the market.
”The truth lies within the data.”