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. 
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.
When choosing an option strategy, the first question to ask is: what are my goals? In options trading there can be several goals. For example, if you are interested in trading stock options, your goals may be one or more of the following.
- Benefit from anticipating that a stock price is going to increase or decrease but without actually buying the stock
- Cover for potential stock losses on stocks currently held as the market declines
- Try to buy stock at a lower price because you believe the price will go down
- Enhance the income you are earning on the stock currently held
- Prepare for major market moves
So in other words you may want to take advantage of a bull or bear market, or you might want to hedge against losses. You also might want to maximize income.
The option strategy you choose will impact your probability of successfully reaching those goals. Traders can generally be classified into two types which are speculators and hedgers. Speculators are more willing to take risk because they are anxious to generate quicker income. Hedgers are more interesting in protecting investments. Hedgers are more in a mode of preventing loss rather than generating gain.
Don’t misunderstand though – all option traders want to make money. That’s why they invest in the options market. But the strategies chosen to reach goals can vary widely. The goal is to let the winning trades become as profitable as possible while cutting the losing trades off as soon as it is discovered they are losers. Eventually you will learn how to calculate your percentage of success based on the successful and unsuccessful trades you make.
Strategies can be very simple lie buying a call option or a buying a put option. But many of the strategies involve many more steps and are delicately balanced sets of transactions involving calls and puts with a variety of strike prices, expiration dates and even underlying assets. Following are some of the more common strategies that can be used to meet different investment goals. This list does not include all the possible strategies though because people develop new ones all the time as they gain trading experience.
Goal: Income
- Covered calls
- Sell naked calls or puts
- Condors
- Credit Spreads
Goals: Take Advantage of Rising Market
- Buy calls
- Bull call or put spreads
- Sell naked puts
Goal: Hedging
- Collars
- Married puts
- Protective puts
Goal: Take Advantage of Falling Market
- Buy puts
- Bear call or put spreads
- Sell naked calls
You can even choose strategies for a stagnant market. For example, if the market is neutral, you might want to choose the straddle option strategy. This strategy lets you anticipate a market move in either direction and limits risk either way. Other stagnant market strategies include strangles, ratio spreads and reversals.
If you have gotten the idea that options investing is complex then you are right. Yet you do not have to start your investing career in options by choosing the most complicated option strategy. Instead you can start with an easier strategy and then gradually progress into more advanced strategies.
Before option investing, first choose your goal and then match the strategy to that goal. With each investment the goal can change…but so can the strategy!
Filed under All About Options by on Jul 27th, 2010. Comment.