Investors have a lot of choices and one of those is the option trading stock options provides. Stock options trading takes place on the major exchanges and is one of the most highly regulated trades. That is good news for smaller investors because it means the option contracts can be bought and sold with safety. Basically, an exchange is an organized marketplace where traders can trade stocks and commodities.
The first exchange listed options became available in 1973 under government regulation. Before the exchanges the options trading mostly took place in the over-the-counter markets. Though large investors dealing in highly customized option agreements still do a lot of over-the-counter option trading, most individual investors take advantage of the exchange traded options.
There are many advantages to using exchanges for trading options.
- Government regulated exchanges
- Exchanges provide clear trading rules
- Efficiently processes trades
- Guarantees contract performance
- Investors can follow prices
There are even more advantages to buying stock options
- Transactions are liquid
- Can create a hedged position
- Can create a speculative position
- Can increase profit potential through leverage
- Can limit risks in most trades
Options listed on stock exchanges have some of the same qualities as listed common stocks. For example, bids are made by potential buyers while offers to sell are made by sellers. In addition, options and stocks can track market price movements. So why not just buy the stock?
There are many reasons why investors might pick the option trading stock options conveys. For example, options have expiration dates so you are not locked into a transaction for an indefinite period of time. Stock options can be used in conjunction with stock purchases to limit losses due to a downward market trend or a falling stock price. Stock options also let you anticipate stock prices you would find favorable with only a small premium payment.
In other words, stock options add versatility to investing that cannot be achieved with only stock buying and selling. The equity option, or stock option, gives an option buyer the right, but not the obligation, to buy or sell stock shares at a specified price by a specified date.
Options are actually derivatives. Derivatives get their value from the security that underlies the financial contract which for stock options is stock. When you buy an option, you are actually buying the right to buy or sell 100 shares of stock because that is the trade unit of equity options.
The terms of exchange traded stock options are clearly defined. You will know up front the strike price, the premium and the expiration date for example. Though you will be watching the price movements of the underlying asset, the options terms are clearly fixed in place. And because the exchanges are regulated, you don’t have to worry about losing your investment due to fraudulent trading. Of course, you will have to carefully choose your broker but quality brokers are registered with the exchanges and have all appropriate licensing.
Most US stock option trades are American style. This means the option holder can exercise the option up to the expiration date.
If you are interested in pursuing the wonderful option trading stock options offers then exchange traded options are an excellent choice. When you are trading options, you want to be spending your time managing your investments.
Filed under All About Options by on Aug 3rd, 2010. Comment. 
Option trading is not for the uninformed, but it is for anyone interested in adding an investment with special qualities to portfolios. These qualities include the ability to protect stock investment portfolios form unexpected market price changes and the ability to leverage the investment by paying the option premium. But to tell you that options trading is simple or risk free would be untruthful.
The Options Industry Council (OIC) is a great place to begin reading about the basics of options. The commodity exchanges also offer important information for traders new to the buying of options on futures contracts. For stock and commodity trades, the following are some of the main exchanges selling stock or commodity options that you will want to check out.
- American Stock Exchange (AMEX)
- Chicago Board Options Exchange (CBOE)
- Chicago Mercantile Exchange (CME)
- Boston Options Exchange (BOE)
- Nasdaq OMX
- New York Mercantile Exchange (NYME)
- Intercontinental Exchange (ICE)
There are others but these are some of the oldest and largest in the world. Each of the exchanges has account rules and all have established certain standards for options trading. For example, according to the OIC, a stock is eligible for options trading only if it is listed on the NYSE, AMEX or Nasdaq and has had a price that is $3.00 or higher for most of its trading days. There also has to be at least 7 million outstanding shares and 2,000 shareholders.
Futures contracts were first traded in 1865, but option trading on futures didn’t come into existence until as late as 1982. The National Futures Association is the first to admit that futures trading is speculative investing. There are several types of future markets. These markets are where the pricing on commodities begin. When you read about wholesale prices, it means the base price for corn or soybeans or even gold have been established through futures contracts.
Following are the major categories for option trading:
- Stock options
- Stock index futures
- Commodities futures
- Bond futures
- Foreign currency futures
- Interest rate futures
When you decide to begin option trading, it will be necessary to choose a broker and open an account. There are different types of brokers. For example, a full service broker will not only assist with transactions but will do research and even make trade suggestions. Of course the commission rates will be higher for a full service broker than for a discount broker who provides limited services. But today you can also trade directly online through an exchange with the exchange itself serving as the broker. Stockbrokers must be licensed by the National Association of Securities Dealers. Futures brokers must be members of the National Futures Association and registered with the Commodity Futures Trading Commission.
When you are ready to do option trading, the first step is to make sure you understand exactly what you are buying and how much it is going to cost you. In the world of options that can get complex. There are premiums, commissions, and transaction fees to consider in addition to strike price. You need to understand how to calculate the option break-even price before you can determine a fair price for the transaction.
It is possible to open either a cash account (Type 1) or a margin account (Type 2). A margin account is more difficult to qualify for because, in effect, you are buying options using credit in addition to a certain percentage of cash. The Federal Reserve has established limits on how much margin is allowed on a transaction.
Though no one likes to say it out loud, you should not begin option trading unless you have money you can afford to lose. On the other hand, all investments have an element of risk so in that sense option trading is not any different from other financial investments.
Filed under All About Options by on Aug 10th, 2010. Comment.
Say the word “option” to many non-institutional financial investors and they quickly lose interest in the topic. The reason they lose interest is because options in the financial world seem to be equated with gambling or high risk. Yet options can play an important role in balanced stock portfolios, so ignoring this investment should not be an…well…option.
Ignoring the play on words, the definition of an option is: a right without an obligation to an underlying futures contract at a particular price and at a particular time. Of course, the definition can raise a number of questions. For example, what does it mean to have “a right without an obligation” and what is an “underlying futures contract” and how is the price set and how much time is allowed?
These kinds of questions are typical when first learning option basics. They are typical and important questions because you don’t want to get involved in options trading unless you understand the concept and the financial terms.
You Have the Right to Exercise…Your Options
The fact is you have the right to an option that is actually a legal right to buy or sell a contract that has an underlying equity or commodity giving it value now and at some point in the future. Equities are usually stocks but not always. You can also buy options on future contracts with a commodity as the underlying asset like corn for example. But people who invest in commodity futures are normally major players in the marketplace because of the size of the investment required. Of course, if you decide to buy the futures contract, you are not actually going to find yourself owning trucks full of corn. That’s because you are buying a contract and not the asset.
Options that are exchange traded, like stocks and commodities, are agreements to buy or sell contracts according to prearranged terms. Those terms include the future price you are willing to buy or sell at and the time limit for deciding if you want to exercise the option. Other terms that are established before the transaction takes place include the quantity of the equity to be optioned and the way the equities will be delivered in the event the option is exercised.
The options transaction takes place in an exchange which is why they are called exchanged traded transaction. You may decide for example, to buy an option on 100 shares of XYZ stock at $5.00 a share within 30 days. This is a futures contract and the underlying equity is the stock. You can buy multiple options and each option normally covers a 100 shares. The $5.00 is called the strike price which is the price at which the option can be exercised.
The definition also states that the option can be exercised at some point in the future. This future date actually represents the date on which the option expires. If your futures contract said you could buy XYZ stock at $5.00 a share in 30 days, you can’t decide on the 31st day to exercise your right. On the 31st day the option has expired. But you can exercise your right anytime from the 1st to the 30th day.
In the Future
Options deal with the future. When you trade in options, you are trading contracts that have an underlying equity and the trading can take place in the future based on a specified price. Underlying equities may be stocks, currencies, silver or gold, corn, soybeans or anything else that can bought and sold. The option is saying that you have a right to purchase or sell a contract based on the current value or a value projected for the future.
Are their risks involved in this type of investment? Naturally there are risks, but you can minimize those risks by making sure you understand what an option is and how it works in the marketplace. Like any investment, the more information you have, the better investment decisions you can make.
Filed under All About Options by on Aug 17th, 2010. Comment.