Traders and investors who participate in financial markets do so with one goal: to make a profit. the markets offer an important universe of assets and financial instruments to achieve this objective. Trading with financial options is one of the markets that has grown the most in recent years. Derivatives markets are an excellent alternative, both for individual traders and for large institutions.
One of the most widespread principles among financial market participants says the following. The possibilities of obtaining greater profits are always associated with taking greater risks. That is the reason why successful trading seeks to maximize results, reducing the risks of losses. This can only be achieved by developing skills and knowledge to intervene in the markets.
In this article, we will talk about the reasons why more and more people trade with financial options. We’ll take this opportunity to give you some advice that we think will be very useful if you want to venture into the derivatives markets.
Why choose financial options trading?
Financial options are instruments that are traded on regulated derivatives markets such as CME Group. They link, through a contract, a buyer and an issuer. By trading options, the buyer will have the right, and not the obligation, to buy or sell an underlying asset offered by the issuer.
To enjoy this right, the buyer will pay the issuer, upon signing the contract, a premium or option price. If the buyer desists from exercising his right, he will lose the premium and this will be the “gain” of the option writer.
In the event that the buyer of the option does decide to exercise his right to buy or sell the underlying, in addition to the premium, he must pay or receive the exercise price. This is the value of the underlying agreed in advance.
These are, to call it something, the basic principles of options trading. And, here, we have a powerful reason to trade options, at least for the buyer. Potential losses from him are limited to the premium paid in case of not exercising his right. In return, he has the possibility of obtaining the underlying at a much better price than in the market.
On the issuer’s side, his main gain is in the premium he gets. On the other hand, if he is obliged to deliver or buy the underlying, the potential for losses is very large. So, do you know where the business is for the issuer in options trading? In the odds. These indicate that in 75% of cases, buyers do not make use of their right to buy or acquire the underlying.
Digital Option vs Binary options
If you are interested in option trading, you have hardly missed binary options which are an exotic type of option available on brokers like Quotex or Pocket Option. Binaries are frequently used to trade on the market.
Binary options have a fixed return, as you will only define whether that asset will appreciate or fall, regardless of how much the price rises or falls. In case of success, the profit can reach up to 98% of the invested amount, but if it is wrong, the loss can be total.
More reasons to trade options
We can divide options trading operators into two large groups. The first group trades with options to hedge other positions. For example, they buy put options to cover long positions in other markets. Or, they buy call options to cover short positions
In the second group are those who speculate on the price movements of the underlying. Many professional traders choose option trading for this.
Another of the great reasons why investors choose to trade options is the good level of leverage. Let’s remember that in the derivatives market this works differently from other markets. The “borrowed” money does not come from your online broker but from the market operator (CME, for example).
But let’s see this with an example. You have a capital of $900 that you want to invest. Also, you have good information that ABC company stock will go up in the next period. In the stock market, each share of ABC is worth $90. So you will be able to buy 10 shares.
Instead, he opts to trade options. Three-month ABC stock contracts are trading in the options market for an exercise price of $95. You will pay $3 per share of a call option.
You buy 3 purchase contracts of 100 shares each (3 contracts x 100 shares x $3). You will have invested your $900 in an options trade.
Let’s see the results
Before the expiration date of your contracts, ABC shares are trading at $103 on the market. On the options market the value is $8 instead of the $3 you paid.
If you bought ABC shares on the stock market at $90 each. And, each share reported a profit of $13, your total return will be 10 shares x $13 = $130. 14.4% of your investment.
These would be your options trading results. Before the expiration date you sell your 3 option contracts for $8 per share (3 contracts x 100 shares x $8 = $2,400). If we subtract the $900 premium paid from these $2,400, your final return will be $1,500. A 166.7% return.
Instead of selling your purchase contracts, you may choose to exercise the right to purchase the underlying. Of course, for this, you must have the necessary capital to pay the exercise price established.
Options Trading Tips
Now, we want to offer you some tips or advice for trading financial options. These recommendations are not “revealed truth.” Success requires a proper trading plan. However, we feel it appropriate to provide some recommendations for those who are exploring options trading opportunities.
As a buyer of call or put options, choose contracts with longer expiration dates. this will allow the underlying price movement more time to develop in the direction you expect.
Conversely, if you assume the role of issuer, select those contracts closest to the expiration date.
As a buyer, go for the cheapest contracts. This can favor your chances of greater profitability. The cheapest financial options usually contain low implied volatility. However, if you have done a proper analysis of the underlying, it may be that it is undervalued and you can take advantage of that. On the other hand, remember that implied volatility tells us the possibilities of price fluctuations. But by no means the direction those movements will take. We cannot know if they will be bullish or bearish. Therefore, the risk of losses is higher.
Finally, before you trade options, have a thorough understanding of the industry sectors in which you will be investing. Among the underlying assets you can find excellent alternatives. With low implied volatility, with a long term to expiration. But, with high potential for the news to come.
Now, we want to propose you a safe and direct path to success in options trading. Your chances of favorable results will grow substantially if you begin to go through it with a solid training. We invite you to train you on free demo account. Become a professional trader.