An Overview of Options Trading
Options trading is incredibly complex, any derivative instrument is for that matter. While its complicated it is still possible to learn how it all works but you’ll need to get the basics down pat first. In this article by our CFB experts we help you with the most important aspects. It usually takes quite a while to master financial concepts but this piece aims to prove that options trading can be very rewarding if you invest in the time and effort required to grasp the fundamentals.
A Definition Of Options
Options can be classified as a financial asset in their own right but usually they are a type of contract that is based on another financial instrument. Options derive their value from other assets hence why they’re known as a derivative. The value these tools acquire is from an underlying security or asset and it gives the holder the right to a future purchase or sale of this underlying asset.
There are usually a whole bunch of terms and stipulations associated with an options contract usually related to how the future transaction will take place. The contract will state the asset type, price, if it is to be bought or sold and when in the future this transaction can occur.
What Is Options Trading All About?
In short people trade options to make money just like they do when they trade any number of other financial instruments. Options trading, while slightly more complicated than trading other tools, allows traders to profit from the price fluctuations of a great number of assets or securities. When one thinks of investing, the first thing that comes to mind is buying shares on the share market. Most are naive to terms like options trading. Buying shares and holding them for an extended period of time with the goal of making long term profits is at the end of the day, one of the most popular investment strategies. It’s also a low risk way to invest provided you’ve done your research and you know what companies to buy. This investment style is known as a buy and hold strategy and long term it can help you grow your wealth. However, if you’re trying to make short term profits you’ll struggle with this. Investors are increasingly looking for ways to make significant, short term profits and options trading is just one active investment strategy that provides this.
The Contribution Of Online Brokerage
The growth in the online brokerage sector has enabled investors to buy and sell instruments on exchanges at the click of a mouse meaning it incredibly straightforward for investors to become more active ‘traders’ if they so desire. There are a growing number of people around the world that trade online in either a part time or a full time basis. Traders buy and sell regularly to try and profit from short term price movements and often can be seen holding on to an instrument for a couple of weeks or days. In Forex trading and CFD trading traders might only hold a security for just a couple of hours. The number of financial instruments that can be actively traded is incredible and options trading in particular is becoming more and more popular.
A Visualisation of Options Trading
We briefly touched on the versatility of options above and this comes mainly from the numerous types of orders that can be made. When it comes to shares a person can only make money in two ways: by either taking up a long position (buy the stock) or short position (sell the stock) depending on your future price predictions. With options, trade executions can take place in a number of ways meaning there are more ways of making a profit.
This is the equivalent of taking a long position in a share you might invest in. If you predict an underlying asset is going to appreciate in value, purchasing a call option gives you the right but not obligation to acquire the underlying security at a fixed price. On the flip side, if you believe a stock is going to fall in price you can purchase a put option which allows you to profit on the down side.
Selling an options contract occurs when a trader wants to cash in on the profits they’ve made by purchasing a call option or when they’d like to minimise their losses. Selling an options contract, which is the exact opposite of buying an option, closes out your long position (purchase of a call option). Another way of selling options is by taking up a short position which is also called writing options. This occurs when taking on the obligation to sell a counter-party the underlying asset at the strike price (call option) or purchasing the underlying asset from them if a put option is purchased. This would all take place if you believed an asset was going to drop in value.
Exercising An Option
This simply means using the option. If an asset price hits the strike price in either a
call or put option contract the holder can exercise their right to buy the underlying security or sell the underlying instrument at the agreed price.
How Can I Trade Options?
Most Australian brokers now offer the trading of options. A basic, yet powerful, feature of all the latest platforms and software packages provided by brokers allows traders to be tuned into the thousands of financial markets available around the world. If trading options is a goal of yours, research some of the local brokers to see if options is part of their suite of services.