Game on the stock exchange. Option for beginner traders
Paul Roberts
03 / March / 22
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Unlimited opportunities for investors with the appearance of the option on the futures market. However, not everyone can take advantage of these opportunities.
What is an option
An option is a contract that gives its holder the right to buy or sell an underlying asset at a fixed price. The peculiarity of the option is that its owner decides whether to perform or not to perform the contract. For example, the owner of futures does not have such a choice
Like futures, the option has its own circulation period, which is set by the exchange. However, there are possible nuances. There are two so-called style options. In the first case, the buyer of the option can exercise it (buy or sell the underlying asset at a fixed price) any day before the expiration of the contract - this is American style. In the second case, the option can be exercised only on a certain date (the expiration date of the option) - this is the European style. The style of the option is determined by the exchange when launching the security.
Depending on which right is fixed in the contract (buy or sell an asset), there are two types of options. A put option entitles its holder to sell the underlying instrument. Accordingly, a call option implies the right of its holder to purchase the underlying asset. Both types of options are traded on the stock exchange at the same time.
Unlike futures, which set one universal price for the underlying asset, options that are traded simultaneously on the stock exchange may have a different strike price (strike). The price of the option itself, at which it is sold on the market, is called the premium and is determined during stock trading. The premium is always paid by the buyer to the seller of the option as payment for the right to exercise that option in the future.
As with futures, when buying a put option, you do not have to have a underlying asset. In the case of an option, everything is even simpler, because it does not express the obligation, but the right to perform the transaction. If you sell a call option, then the buyer gets the right to buy your underlying asset, and you, in turn, are obliged to sell it. But, as in the case of futures, you can "close" your commitment by buying a counter option.
The option allows the trader to design and use many different trading strategies. Depending on the strategy chosen by the trader, the sequence of actions taken by him on the exchange will be different. However, there are general basic principles.
Step 1: buy an option
Experienced traders say that it is better for a novice player in the options market to buy than to sell options. From an economic point of view, buying a call option is no different than selling a put option. However, in the first case you have only the right to buy the underlying asset, which you can use at its discretion, and in the second - the obligation to buy the instrument if the option buyer wants sell it.
In addition, buying an option, you get limited risks and potentially unlimited profits. One of the main advantages of buying options is that the investor has unlimited profit potential. If an investor buys a CALL option, he can make a profit as long as the price of the underlying asset continues to rise. The second advantage is that the investor's risk is limited and defined. All he can lose when he buys an option is the size of the premium plus the broker's commission. At the same time, of course, unlimited potential is not a guarantee of profit.
If you expect the price of a futures contract on the market to fall - buy the put option. If you think that the price will rise - buy a call option.
Unlike futures, options trading does not use a "shoulder", so to buy this security, you will need to pay its full cost (premium).
Step 2: monitor the change in quotations
As with other securities, the option price is determined during stock trading. Accordingly, if your option is more expensive - you can sell it and make a profit by increasing the premium. However, it is necessary to remember some features inherent in the option.
First, it is natural that the option price depends on the price of the underlying asset. So, to predict the change in the price of your option, you can follow the futures quotes on the index of stocks, which in turn depend on the values of the index. Thus, by predicting the movement of the index, you can predict changes in the price of your option.
However, such a forecast may not be enough. It may happen that if the underlying asset rises, the price of your option will remain unchanged. The fact is that the price of the option also depends on time. The less time left until the expiration date of the option, the less the premium for it.
In addition, the option price depends not only on the size but also on fluctuations in the price of the underlying asset. For example, when the uncertainty in the financial markets increases, the value of the option contract increases, and vice versa, when the unrest in the markets decreases, the value of the option contract decreases.
Step 3: sell the option
If the price of your option has risen to a sufficient level, according to your estimates, or if you expect the price to fall in the near future - you can sell the contract and record a profit.
However, it is not always necessary to buy an option in order to sell it. An option sale is a contract for a future transaction. When selling an option, keep in mind that in this case the situation for you is the exact opposite of the buyer: you get a fixed profit in the amount of the option premium and potentially unlimited risks.
If you sell a put option (you undertake to buy futures at the option of the option holder), then if the futures price decreases, you will have to buy it more expensive - at the price specified in the contract. Accordingly, the more the futures price falls, the greater your loss.
If you sell a call option (you undertake to sell futures at a fixed price) - then you suffer losses when futures become more expensive. The potential amount of loss in this case depends on whether your option is covered - whether you have the same futures. If the buyer of the option asks you to sell him the futures you have available, your loss will be equal to the amount of unearned profit you could make by selling the futures at the market price less the option premium. Otherwise, you will have to buy futures at the market price to fulfill your obligation under the option.
You can avoid losses by buying another call option on the market in advance. However, in this case, your profit is reduced by the amount of the premium on the purchased option.
Step 4: Reduce the risks with the option
Another important function of the option, thanks to which it has earned its popularity in global stock markets, is to reduce the risks of the investment portfolio. If you are already trading stocks or futures, the option will be useful to you as a tool to protect against fluctuations in the value of instruments in your portfolio. "Suppose that while waiting for the publication of important statistics, the investor is concerned about the possible decline in the value of his portfolio. In order to reduce his risks, he can buy a PUT option on futures on the Stock Exchange index, which gives him the right to sell futures on the UX index at a pre-determined price for a certain period of time. Thus, if the UX index falls, it will reduce the value of the investor's portfolio, but thanks to the PUT option he has the opportunity to exercise his right to sell futures on the UX index at higher prices, which compensates for its losses in the spot market.
Thus, the option for the investor acts as a kind of insurance policy. The investor buys a put option (fall insurance) for a small fee, and in the event of a decline in the stock market will receive compensation (in the case of competent selection of the instrument - an option with a specific expiration date and a specific exercise price). In this case, if the stock market does not decline, the investor will lose only the paid value of such insurance (the amount for which the option position was opened).
What to remember
Experts say that the option is a much more complex instrument than futures, and therefore advise to start trading in the futures market with the latter. If you do not have enough experience in the futures market, you should first read the special literature and try your hand at training auctions. Working with options requires an understanding of the nature of the instrument, just as in any other example, not only in the field of investment. Will the beginner be able to learn to work with tools? It depends on the investor. It is more difficult to work with tools than with stocks, but this difference is the same as in the case of cars: driving a cart (stocks) is really easier than driving a sports car (options).
If you have seriously decided to start trading options, then do not forget that the more opportunities provided by one or another tool, the more dangers it poses in the case of incompetent behavior. All the disadvantages of using the option to implement investment and trading strategies are a mirror of the merits. In other words, incompetent handling of the option can turn every advantage into a disadvantage.
New tools: investing in futures in detail
Exchange rate and gold price futures are a real find for those who would like to keep their money in foreign currency or gold, but cannot or do not want to buy these assets. What are the features of investing in new stock market instruments, and how much you can earn on futures trading.
Where it all began
In early 2010, the Stock Exchange launched a unique tool that allows traders to earn extra profits even in a falling market - futures on the Stock Exchange index. In just one year, this instrument has become the most liquid in the country's stock market.
Later in January 2015, the futures market was replenished with new instruments - currency futures and futures for the price of one troy ounce of refined gold appeared.
The mechanism of futures trading on exchange rates and gold is no different from futures trading on the stock index on the Ukrainian Stock Exchange. The difference between the instruments is only in the underlying asset.
The obvious benefits
The main advantage of futures is the ability to earn on the course without buying a physical asset. First of all, futures will be useful to those people who want to buy dollars to protect their savings. Currency futures allow you to earn on the course without buying physical currency. The simplest method of hedging is when we expect the dollar to rise against the hryvnia. In this case, you just need to buy futures and then sell at an increased price.
Exchange rate futures are a useful tool that allows an investor to insure himself in the event of a sudden fall in the price of gold or the strengthening of $. If a private investor has cash dollars, but he does not want to sell them, and he has fears that the rate will fall, he may open a short position (ie sell a futures contract), thus protecting himself from losses in case of reduction of the course. With a short sale on the futures market, you can earn by reducing the value of any underlying asset, including the dollar-hryvnia exchange rate. In addition to such investments, which experts call "risk hedging", you can make money on futures and speculating on them.
The second advantage of futures is the ability to use the instrument without paying its full cost. The total price of contracts is quite high: in currency futures - the equivalent of $ 1,000, in gold futures - the cost of 1 troy ounce of gold. In fact, to take advantage of futures, it is enough to have only part of the cost. To buy futures with a face value of 1 thousand dollars, you need to pay only 20% of their value in $, the minimum threshold for entering into the agreement will be 4,600 $. Guarantee guarantee under the gold futures contract - 10%.
In general, currency futures are the most promising instrument on the market, experts say. SME, or the Chicago Mercantile Exchange, is currently the world's largest futures market. Currency futures on it account for the lion's share of turnover. The most liquid are the so-called mini-futures, the most popular and speculative currency futures are futures on the currency pair Euro / US Dollar. Currently, the main problem of currency futures, like any new instrument, is their liquidity. Given the positive changes that occurred in recent days in the interbank foreign exchange market, which led to real market exchange rates, are confident that interest in foreign exchange futures will grow day by day.
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Paul Roberts
Paul Roberts 51 years old Born in Edinburgh. Married. Studied at University of Oxford, Department of Public Policy and Social Work. Graduated in 1997. Works at Standard Life Aberdeen plc.
