Are you tired of the same old investment strategies? Then, you should explore new ways to profit from the financial markets. This includes trading FTT and options, among others.
Our attention, however, will be on options trading, a form of derivative trading that allows investors to speculate on the future price movements of an underlying asset, such as a stock, an index, a commodity, or a currency.
Options trading has several benefits and a corresponding number of significant risks.
Therefore, before you dive in, make sure you have a firm grasp on options contracts, the Greeks, and the numerous options trading strategies that can propel you toward your financial objectives.
This guide will provide you with the knowledge and skills needed to navigate the options market effectively.
The Basic Concept of Options Contracts
An option contract is a legal agreement that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (strike price) on or before a specified date (expiration date).
The buyer pays a fee (a premium) to the seller (writer) of the option contract for this right. On the other hand, the seller has the obligation to fulfill the contract if the buyer exercises his or her right.
Types of Options
There are two main types of options: calls and puts.
A call option gives the buyer the right to buy the underlying asset at the strike price, while a put option gives the buyer the right to sell the underlying asset at the strike price.
The buyer of a call option expects the price of the underlying asset to rise above the strike price before the expiration date, but the buyer of a put option expects the price of the underlying asset to fall below the strike price before the expiration date.
The concept of the Greeks
One of the most important concepts in options trading is the Greeks. They are a set of mathematical variables that measure the sensitivity of an option’s price to changes in the underlying asset’s price, time decay, and implied volatility.
The Greeks are named after the letters of the Greek alphabet, such as delta, gamma, theta, and vega. Options traders need the Greeks to understand the behavior and value of their options contracts and to design and execute effective options trading strategies.
Delta measures the change in the option’s price for a one-unit change in the underlying asset’s price. It ranges from 0 to 1 for call options and from -1 to 0 for put options.
You can interpret Delta as the probability of the option being in the money (ITM) at expiration or the equivalent number of shares of the underlying asset that the option represents.
The change in the option’s delta for a one-unit change in the underlying asset’s price is what Gamma measures. It ranges from 0 to infinity for both call and put options. Gamma can be interpreted as the rate of change of the option’s delta or the curvature of the option’s price curve.
Here’s an example to understand Gamma better.
If there’s a call option with a gamma of 0.1, it means that the option’s delta will increase by 0.1 for every $1 increase in the underlying asset’s price and that the option’s price curve is convex.
Theta measures the change in the option’s price for a one-unit change in time. Unlike others, theta is always negative for both call and put options, meaning that the option’s price decreases as time passes.
For instance, a call option with a theta of -0.05 means that the option’s price will decrease by $0.05 for every day that passes and that the option holder loses $0.05 per day due to time decay.
Vega is always positive for both call and put options, meaning that the option’s price increases as the implied volatility of the underlying asset increases. It measures the change in the option’s price for a one-unit change in the implied volatility of the underlying asset.
Options trading strategies
Traders looking to make a profit from different market scenarios make use of option trading strategies. The strategies are combinations of buying and selling different types of options contracts on the same or different underlying assets.
Options trading strategies can be classified into four categories: bullish, bearish, neutral, and volatile.
- Bullish strategies: You can use them to make a profit from an increase in the price of the underlying asset. Some examples of bullish strategies are covered calls and protective puts.
- Bearish strategies: These are designed to profit from a decrease in the price of the underlying asset. Bearish strategies include naked call and bear put spread.
- Neutral strategies: When the prices of underlying assets are stable or sideways, neutral strategies like straddle or strangle are used to make a profit.
- Volatile strategies: They give edges when there is an increase in the volatility of the price of the underlying asset. Examples in this category are butterfly spreads and iron condors.
While options trading is a rewarding form of derivative trading, it only benefits investors who are willing to learn and master its fundamentals. The Greeks and other strategies discussed in this article can provide insight for you on how to execute your trades effectively.
Also, you should always seek to further explore the world of options trading through learning, practice, and risk management and to utilize the resources available to you to enhance your skills and performance.