intro – options trading:
Options trading is buying and selling of option contracts either on an exchange or over-the-counter(OTC). An Option is a right(but not an obligation) to either buy or to sell, a specified amount or value, of a particular asset, at a fixed exercise price(called strike price), before or on the expiration date. When trading options that give you the right to buy, it’s a “Call” option. And when trading options that give you the right to sell, it’s called a “Put” option.
They can be hard to understand in the beginning, since options trading is an advanced level game. Calls and Puts are distinct types of options and trading one type does not involve the other. In options trading, an option to buy 100 shares of XYZ corp. at a specified price, in the future would be a call option. In contrast, an option to sell 100 shares of XYZ corp. at a specified price, in the future would be a put option. These two types of options trading contracts or the transactions that may happen in the future, have no connection to each other.
settlement – options trading
From a settlement point of view, there are two kinds of options trading contracts. Physical-delivery option and Cash-settled option. A physical-delivery Call option, gives it’s owner the right to receive physical delivery of the underlying asset. While, physical-delivery Put option gives it’s owner the right to make a physical delivery.
The underlying asset could be barrels of Crude Oil, Gold bullion, USD, Apple, Google or Tesla stock for instance. However, owner of the option will only exercise if the current market price is favourable relative to exercise price.
Cash-settled options trading works in the following way. For a Call Option, if market price of underlying asset is higher than exercise price on exercise date, the owner gets paid the difference. If market price is lower than exercise price, owner will not exercise the call option.
On the other hand, a Put option will only be exercised if market price of underlying asset is lower than exercise price. Consequently, the owner of a cash-settled Put option will receive the difference in cash in this scenario. If market price is higher than exercise price, owner will not exercise the put option.
options trading nomenclature
For a beginner, options trading may feel like a very unfamiliar world. There are very different terms used that are not commonly used in other asset classes.
option holder & option writer
In options trading, option holder is the person who buys the right conveyed by the option. On the other hand, the option writer is obligated, if and when assigned an exercise, to perform according to the terms of the option. An option writer who has been assigned an exercise is known as assigned writer.
In options trading, exercise price, is the price at which the option holder has the right either to sell or to buy the underlying asset.
Expiration date, in options trading, is the date on which the option expires. At such point, the option holder no longer has any rights. And the option no longer has any value.
style of option
In options trading, the style of an option refers to when that option is exercisable. There are generally speaking, three types of options. American style, European style and Capped. An American-style option may be exercised any time prior to it’s expiration. A European-style option may only be exercised during a specified period before the option expires.
A Capped option will be automatically exercised, if and when the market price of the underlying asset hits the specified cap price, before option expiry. Capped option, may also be exercised like a European option, during a specified period before expiration.
In options trading, premium is the price that the option holder pays and option writer receives for the rights conveyed by the option. Unlike the rest, this is not a standardised term of an option. The premium does not constitute a down payment. It is set by the writer and holder or their brokers.
long and short positions
In options trading, the word “long” refers to a person’s position as the holder of the option. While the word “short” refers to a person’s position as the writer of an option.
covered and naked call
In options trading, if writer of the call option owns the underlying asset, for the specified amount, the option is called a covered call. If he doesn’t, it’s called a naked call.
at, in and out of money
In options trading, “At the money” means that the current market value of the underlying asset is the same as the exercise price.
A call option is said to be “In the money”, if the current market price of the underlying asset is above the exercise price. A put option is said to be “In the money”, if the current market price of the underlying asset is below the exercise price.
A call option is said to be “Out of the money”, if the current market price of the underlying asset is below the exercise price. A put option is said to be “Out of the money”, if the current market price of the underlying asset is above the exercise price.
current options trading market
Financial institutions and large companies use options contracts frequently to hedge risk in their trading portfolio. For instance, gold produced by a mining company who wants to hedge a drop in gold price. They will buy a put option on Gold, for the quantity they expect to produce. If the price of the gold falls in the future, they will still be able to sell at the exercise price in the put. However, if the price of gold rises beyond the exercise price of the put, they will not exercise the option. Instead they will sell at (the higher) market price.
Large financial institutions also use their stock of assets posted as collateral or reserve capital to write bespoke OTC options. They do this to generate revenue from stock sitting idle in their vaults. In addition, trading options also offer opportunities for speculation. For instance, a trader can predict that the price of an asset will move in a particular direction. He can then, buy a put or call option which will yield a profit. If the prediction is correct.
Most common asset classes in options trading-
- Forex (FX) market
- Bond Markets (also interest rates)
- Equity Market (single stock and composite index options)
- Commodities Market (Gold, Crude Oil etc.)
basics of trading
zero sum game
Many people begin trading options without fully understanding the fundamentals of the contract. For each trade there is a winner and a loser. Even if you do not exercise the options as part of your trading strategy, you are still paying premiums. Long-term success in options trading comes from mastering three disciplines. If you are a successful stock or fx trader, you are probably familiar with these rules. Firstly, you need a proven trading process that works for options trading. Secondly, sound money management techniques can go a long way to helping you win the options trading game. Finally, any time your emotions control your trading, you are likely to lose.
As an individual in the options trading exchange, you are up against the biggest and the best in the world. So, it is important to get access to tools that experienced traders use. Otherwise, you are playing with a handicap. Professional traders have models to calculate the fair value of underlying asset when trading options. And to decide whether to play short term or long term market correction game. For instance, STOKAI is one such tool. You can read more in FAQs on how to use this.
Go through books and papers on options trading written by well known authors. Generally, thrill seekers tend to dive in straight into the markets. There is no skipping through when it comes to trading complex products like options. Each successful trader has had their elbows in the mud. You will not be an exception.
capital and money management
Do you have a lot of capital for trading as well as expenditure on infrastructure and operation? In general, we would not recommend trading for an account with less than $25,000 capital. Let’s say the dividing line between a high- versus low-capital account is $100,000. Capital availability affects many choices. The first is whether you should open a retail brokerage account or a proprietary options trading account.
With a low-capital account, we need to find strategies that can utilize the maximum leverage available. Of course, getting a higher leverage is beneficial only if you have a consistently profitable strategy. With a low capital, you will always be chasing high risk trades to make a reasonable profit. So, this is not a good position to be in.
An experienced trader has strong risk management practices and emotional stability. Hence, doesn’t need the guidance given by a proprietary options trading firm. But, less experienced traders may benefit from the imposed restraints.
Finally, the soft skill needed when trading options or any asset class for that matter. Fear, anxiety, and greed are common traits in everyone. Keeping them under control is an ongoing effort. When they take over, your trading results will suffer. Instead of fear, some of you are planning to trade because of the love of thrill and danger. Or an incredible self-confidence that instant wealth is imminent. This is also a dangerous emotion to bring to independent trading. Also, the reason, almost 70%-80% of retail traders lose money. Instant wealth is not the objective of trading. Therefore, the ideal trader is someone whose emotions have found the right balance between fear and greed.
It is important to spend some time learning the history and basics. This time spent will yield dividends when you are trying to predict movement of an asset. Also remember that you are more rational before you place a trade. So, it’s important to set some rules. If you like market conditions and they fit what your rules suggest, go for it. If the conditions for the rules don’t fit what you see in the markets, don’t trade for it’s own sake. You don’t have to trade every day. The point of having rules is to run them to your favour, and not let them run you.
Day trading follows the same rules we use for life. Successful trading is the art of using knowledge and skills at the right time. It is also essential to set some limits once you open a position. For example, you may impose a limit on yourself to not keep a trade open for more than 20 days. Finally get access to good tools that can help you achieve your trading goals. It’s best to try out a lot of things on paper money accounts before risking your capital.
Despite of all the rules, limits and right mindset, random events will happen. So always have a contingency plan. A perfect system or rules don’t exist. And, this is a good thing. Otherwise, someone will work it out and own half of the free world. All algorithms, tools, systems and rules are based on a snapshot of data. So always pay attention to news and data on a given day.
how to apply this to trading
STOKAI provides daily prediction using algorithms based on all factors that impact commonly traded options. Then, it evolves the forecast over 10 days in the future. Tutorial and brief user guide is available here – Tutorial. If there are any issues, please contact our customer services team.
Stokai is a product of Rumble Horse Tech ltd. A company registered in England.