People interested in trading options may be talking about trading stock options or trading options on futures contracts. But the concepts underlying these types of financial trades are the same. An option is simply a right, but not an obligation, to buy or sell some sort of financial product. The financial product may be a stock or it may be a contract that has an underlying asset that is being bought and sold in the marketplace. The future contract itself is an obligation that is placed on the buyer and the seller like any other contract, but when trading options on futures contracts you are talking about the buying and selling of the futures contract and not the commodity.
When comparing stock options to options on futures contracts, there are some similarities and there are some differences. A stock option represents a contract to buy 100 shares of stock that serves as the underlying instrument. An option on a futures contract represents one futures contract that also gets its value from the price of the underlying instrument which are non-equity assets like commodities.
Options for both stocks and futures contracts must outline the specifics of the transaction which includes naming the underlying commodity or equity, delivery and price among others. Both types of options also have calls and puts which indicate the equivalent of bets on whether the price of the underlying asset will rise or fall. A call option means you expect the price to go up. A put option means you expect the price to go down.
Both types of options also have a premium attached. The futures contract itself does not have a premium, but the options on the futures contract does. The term premium refers to an amount a buyer pays a seller for gaining the privilege of not having to buy the underlying asset in the event the price movements are not beneficial to the buyer. It is the most a buyer can lose on a contract no matter what the price of the asset does in the marketplace because the buyer can choose to not exercise the right on a losing transaction.
Learning About Volatility
The amount of volatility in options refers to price action. Volatility addresses the propensity of the price of the underlying security to go up or down in the marketplace. In a nutshell, there is a relationship between the market conditions that affect the volatility of an asset and the volatility of the option itself but that relationship may not be an exact correlation.
Estimating the possible price swings over the life of an option is one of the most complex calculations in options trading. There is software available that can simplify the process, but investors need to understand the concept of volatility. The desirability of volatility depends on your option position. For example, if you are long in the option then volatility is a benefit for both put and call options.
The more volatility there is in the marketplace, the more likely the option will be in the money. That is why more volatility leads to higher premiums.
Two measures used to determine the relationship between the price of the option and the price of the underlying asset are delta and theta. The terms are called Greeks.
- Delta – a formula to measure the relationship between a change in an option’s price and a change in the price of the underlying asset of the futures contract. Delta represents the percentage rate of change between prices. Values can range from -100 to 0 of talking about put options. Delta values range from 0 to 100 if talking about calls. Sometimes the delta ranges are expressed in decimal form.
- Theta – a formula that measures time decay. Time decay is the rate of change in the time premium. The time premium is the value to the option price due to the remaining time before contract expiration. Theta values increase from zero. The higher the Theta measure the more volatility exists due to time decay.
There are many option pricing models including the Black-Scholes and Cox-Ross-Rubinstein models. You don’t have to complete the calculations yourself but you do need to understand the potential impact of volatility in the buying of stock options and options on futures contracts.
Filed under All About Options by on May 5th, 2010. 
A call option is a particular type of option trade. When you read about options trading, the first two terms you learn are often call and put. These are like the yin and yang of options investing. A call lets you speculate that underlying asset prices are going to go up. The put lets you bet that the prices of underlying assets are going to fall.
Many options traders begin their trading career in this type of investment by purchasing call options. A call option gives you the right, but not the obligation, to buy or sell an underlying futures contract or stock at a future date for a specified price. You “go long” when you have the right to purchase. You “go short” when you have an obligation to sell.
When a call option is exercised, the seller of the option must give up control of the stock or futures contract. If the call option is allowed to expire, the seller gets control of the underlying asset back. So you can see that a call option is an actual contract between a buyer and seller and there are specific terms in the contract.
Two of the key words in the definition of a call option are “right” and “obligation”. The call option gives you a right to exercise the option, but you are under no obligation to do so. On the other hand, the seller has an obligation to sell you the underlying asset if you decide to exercise your right.
The Goal
The goal of an investor buying a call option is to make money on rising asset market prices. The hope is that the price of the asset will rise and the option price will enable the buyer to purchase the asset below market price. If the market price never reaches the strike price, then the option can simply expire. The buyer loses the premium and the transactions costs but that is all.
That is another reason why beginning investors choose call options at first. The upside profit potential is virtually unlimited. Of course, the strike price and the timing of the contract will determine if the call option buyer is successful.
Naturally the seller hopes that the option stays out of the money. In that case the seller gets to keep the underlying asset plus the premium and fees paid by the seller.
Call options can be purchased for stocks, bonds, agricultural commodities, precious metals, interest rates and many others. Once the call option is in place, the seller cannot sell the underlying asset included in the option terms to anyone else.
Watching the Market
Investors learning how to complete successful call option transactions can watch the market for a period of time and witness how the big investors perform. When the market indicates large volumes of call options during the day for a particular asset then you can probably assume the investors expect the price to rise in the near future. The charts indicate expiration dates so you can even see how soon the investors expect the prices to rise.
Call options naturally play a role in options strategies. For example, call options are used in long and short straddles. A straddle is a option strategy that is a spread. For example, a long straddle balances a call option and a put option in a way that minimizes risk of loss while maximizing speculation.
Filed under All About Options by on May 11th, 2010.
Understanding call options is not difficult. The difficulty comes when it’s time to learn how to price break-even points on transactions in conjunction with timing of expirations. The calculations get even more complicated when hedging calls and puts in order to maximize profit and reduce potential losses.
A call option is a right given to a buyer and that is the right to purchase an underlying asset like stocks or commodity futures contracts. When you look at a financial table that lists call options you will discover multiple options with a variety of strike prices. The number of options reflects the fact that the market never sleeps and prices of underlying instruments will regularly change.
It is not just strike prices that can vary either. The expiration dates will also vary. LEAPS options are considered to be long term and expiration dates can be up to 3 years in the future. But many call options have expiration dates stated in months.
Buying Call Options
When buying call options, you are said to go long, meaning you hope to buy an underlying instrument at a profitable price compared to the strike price. You have until the option expiration date to exercise the option. What you pay for the option is called a premium and the premium goes to the option seller.
The long call can be profitable when the option is in the money. This means the strike price of the underlying asset is less than the market price. For example, a stock option strike price is $25 and the market stock price rises to $28. The $3 is potential profit after including the premium and transaction fees in the net profit calculation.
When the market price is higher than the strike price, you have several options. You can exercise the call option and take ownership of the underlying asset whether its stock or a futures contract. After exercising the long call, you now own an asset you can resell in the marketplace at the higher market price. Since the market price is higher than what you paid for the underlying asset after exercising the long call, you now have made a profit.
Another option you have when the option is in the money is to sell a call for the same underlying asset with the same strike price and the same expiration date. The call option you sell will have a higher premium value. You can continue to do this as long as the market prices are rising. It’s easy to see how profitable call options can be in a bull market.
Selling Call Options
If you sell call options, it means you are selling a right to buy an underlying asset at a specific strike price and by a specified exercise date. If the option expires, you earn the premium paid by the buyer. If the buyer exercises the right, then you are obligated to sell the underlying asset. Unfortunately, the only reason a buyer would exercise the option is because the market price of the underlying asset is higher than the strike price
Selling a call option is called going short. When the market price of an asset rises above a strike price, the option will be matched with an option buyer. The buyer is going to exercise the option under these conditions. If the seller does not own the underlying asset, he or she will have to go into the marketplace and pay the higher price to gain possession of the asset to sell to the buyer.
That is why they say there is theoretically unlimited loss risk when you go short. A covered option is one where the seller owns the underlying asset supporting the option contract. This can limit the amount of risk depending on what the market price is doing.
Call options offer much potential as profit makers as long as you understand how the transactions work. It is important to first learn the terms and market operations before trading. It’s simple advice that can earn you a lot of money while also limiting your risk of loss.
Filed under All About Options by on May 18th, 2010. 1 Comment.