Friday, 14 July 2017

What Are Options And How Do I Trade Them

options trading

When we talk about finance, an option is a contract which gives the buyer or owner of the option the right, but not the obligation, to buy or sell an underlying asset or instrument at a specific strike price on a specified date, depending on the form of the option ie you don’t get to own the share, rather the contract to control them.

The strike price may be set by reference to the spot price (market price) of the underlying security on the day an option is taken out, or it may be fixed at a discount in a premium. The seller has the corresponding obligation to fulfil the transaction—to sell or buy—if the buyer (owner) "exercises" the option. In reality when we trade options the option is rarely exercised. An option that conveys to the owner the right to buy at a specific price is referred to as a call; an option that conveys the right of the owner to sell at a specific price is referred to as a put. This means we can make money when in a bull or bear market, ie when the stock price is going up or when the stock price is going down.

The seller may grant an option to a buyer as part of another transaction, such as a share issue or as part of an employee incentive scheme, otherwise a buyer would pay a premium to the seller for the option. A call option would normally be exercised only when the strike price is below the market value of the underlying asset, while a put option would normally be exercised only when the strike price is above the market value. When an option is exercised, the cost to the buyer of the asset acquired is the strike price plus the premium, if any.

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When the option expiration date passes without the option being exercised, then the option expires and the buyer would forfeit the premium to the seller. In any case, the premium is income to the seller, and normally a capital loss to the buyer. Of course all of this buying and selling happens via your broker, so make sure you have a good broker working on your side.

The owner of an option may on-sell the option to a another person or third party in a secondary market, in either an over-the-counter transaction or at an options exchange, depending on the option in question. The market price of an American-style option normally closely follows that of the underlying stock, to be expected, being the difference between the market price of the stock and the strike price of the option.

The actual market price of the option may vary depending on a number of factors however, such as a significant option holder may need to sell the option as the expiry date is approaching and does not have the financial resources to exercise the option, or possible a buyer is trying to amass a large option holding. Remember, the ownership of an option does not generally entitle the holder to any rights associated with the underlying asset, such as voting rights or any income from the underlying asset, such as dividends. As we said, it’s all about the contract.

The options we trade have an expiry date, usually the first Friday or third Friday in the month.

If you trade your options in a spread betting account the profits and CGT are tax free in the UK! If you live in the UK just read that again – Wow!

Want to learn more?

Sign up for our FREE webinar on how to trade Options using a simple, highly profitable Squeeze strategy.


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