My passion is trading😉 and has been for five decades.
I have traded all asset classes and used many different strategies and techniques over the years. There are times when the markets increase in volatility that using options becomes very attractive.
Before deciding to use options, you must have a longer-term view of where you expect the market to be heading. I always advise guys coming through our courses when we get to options to buy options as this way you limit any potential loss from day one. Another advantage of buying options is you do not have to micromanage the risk.
Although it is best to buy options it does not mean you have to long the market. There are two main types which are – call options, as the buyer of the option you expect the market to trend higher and put options, as the buyer you expect the market to trade lower. The key consideration of an option is that it provides the buyer the right but not the obligation to accept a position at a given time in the future. Options are valued off the underlying contract which if using the traditional exchanges is the futures contract or otherwise the cash or physical market.
Key elements of an option:
Strike price – the market price used as the basis.
Premium – The cost to the buyer for limiting his loss and providing him with control.
Volatility plays a major role in the premium of an option along with duration. Higher volatility will increase the premium as will a longer duration to expiry.
Options are available from hours to months.
Traders that trade options as a business are fixated on the `Greeks`, gamma, delta, vega, theo, and theta as they use these to provide the intrinsic value of options.
At expiry, the option will be abandoned if the market price is against the buyer or exercised if the market price is favourable.
There are many strategies available for trading options. The two I favour most are straddles and strangles. These are useful at times of high volatility, especially if you feel the market is due for a big move but uncertain of the direction! Both strategies include call and put options, which provides you with a long and short position in the same contract with the same expiry. The key difference is a straddle will use the closest strike price for both (At-The-Money) whereas the strangle will use strike prices further away from the current market (Out-of-The-Money), which is favourable for the seller as although he receives less premium the market has to move further before the buyer will be in profit (In-The-Money). The buyer of the strangle will do this to reduce the cost of the premium. The buyer of a strangle must consider the premium cost involved of both options.
As the buyer of an option the maximum you can lose is your premium. I always describe is as taking out an insurance policy, its just in case! With insurance it’s just in case there is an accident, with options, it’s just in case your view is wrong!
Once I am in the money (ITM) they become interesting. I like to use the underlying to hedge my options positions.
An example:
Gold is trading at $1898.2.
Strike price (ATM) $1900.0 as nearest.
Buy a December call option for $1.4 premium, depending on the underlying, in this case we are using futures, and this cost $1,400 in real money as $10 per tick (pip).
My breakeven level is $1901.4 calculated as $1900.0 (strike) plus the premium of $1.4 Anything above $1901.4 is a potential profit. When I consider the market is preparing to turn, I hedge my option position by selling the futures contract. Each time the market drops I buy the futures back and each time it rallies I sell again. It’s possible to make substantially more from the futures hedging than the premium paid out! However, I must always sell the future first as a hedge, as if I bought the future first, I would actually be doubling my position!!
Options are useful; however, the key is you must be right and ITM at least once before expiry to benefit from them.
Selling options has unlimited risk and requires constant monitoring to manage the risk. Trending markets or static markets are preferred by sellers, although it depends on the strike price used!
Most options expire worthless; however, this is due to many buyers using them as protection (hedge) against the underlying or traders buying far out-of-the-money options to reduce the premium cost.
Register for Symax Fintech Academy workshop on options and discover how options can become part of your trading/investing strategy.