Understanding the Concept of Options Trading
Investors in the Australian market are always on the lookout for other asset categorization, other than shares and mutual funds. The good news is that serious trading platforms now have different investment choices which can bring you excellent profits.
A perfect example is options trading. Although it may be quite overwhelming to some people, all you need to understand are a few pointers, and then you can invest. This leads us to explore the whole concept of options trading and what it entails.
What Is Options Trading?
Options trading is not a recent trading model. On the contrary, it has been in existence for decades. Only that right now, the market has gone beyond limits in terms of the number of investors and contracts.
The way you trade major pairs in the Forex trading account is almost the same way you’d trade options. The only difference is that unlike stocks in which there are shares, options usually come in two distinct types: call and put options. Again, unlike stocks where you are trading in shares, options involve what are known as contracts.
Thus, if you invest and own the contracts, you are at liberty to sell/buy underlying security just like you would buy or sell a stock. Otherwise known as derivatives, options usually derive their value from an underlying asset. This is the very reason why they are often considered to be less risky in comparison to other financial products.
The prices for the options are pre-determined, and you need to sell/buy at or before the expiry of a contract. Most investors use options for speculation, by betting on securities to either go up or down. Options are also used to hedge risk against trading positions in the market.
How Options Trading Works
There two distinct features which play a crucial role when you are trading in options. These are:
- Call options
- Put options
The call option allows you the right but not the obligation, to buy an asset at an already predetermined price. You stand to benefit if the cost of the underlying asset goes up In the event the price of the underlying asset fails to rise above the predetermined price before or at the time of expiry of your contract; then the call option becomes more or less worthless.
It, therefore, becomes somewhat cheaper to buy the underlying asset right from the market rather than from the Options. Investors usually buy the call option with an expectation that the prices of an underlying asset will go higher; hence, they can reap the rewards.
The put option allows you a right, not an obligation, to sell an asset at predetermined prices. You stand to benefit if the price of an underlying asset goes down. Just like the call option, you need to sell the asset or before the expiration of the contract.
An investor buys the put option with an ex expectation that the prices of underlying assets will go down, before the expiry of the contract, to make a profit. In the event the underlying asset fails to fall below the strike price, before or at the date of expiry, then the put option becomes more or less worthless.
Situations When It’s Favorable to Buy a Call Option
You can buy the call options under the following market environment:
- When your analysis shows an expected price rise in an underlying asset, more than implied volatility.
- When your analysis shows an expected price rise of an underlying asset, with an increase in volatility.
Situations When It’s Favorable to Buy a Put Option
You can consider buying the put options under the following market environment:
- When you know that the prices of an underlying asset are expected to go down
- When you assume that the volatility will not push up the prices quickly.
Most investors know that options trading can change fortunes. Therefore, in modern trading, you can use the readily available technics and strategies to speculate when the market is favorable for the type of options you are holding.