Why trade Options?
What are Options?




Why trade options?

Options are one of the most profitable tools available to traders today and Options trading provides a lot of advantages over other investment vehicles like:

Leverage

Leverage allows you to control a large amount of goods with a very small investment.

For example, let's say you have $1,000 to invest. This amount could be invested in 50 shares of XYZ ($20 per share). But to increase leverage, you could invest the same $1,000 in 5 Option contracts (1 Option contract equals 100 shares and in this case 1 Option costs $2). You would then control 500 shares instead of just 50 (leverage of 10 to 1). Say you bought $18 Call Options for $2 while the underlying shares were trading at $20. If the market moves up to $22, the options will be worth $4 because you can exercise your Options at $18/share. So, while the shares only went up 10%, you doubled your money because you can now sell back the Options for $4. In our example, your $1,000 investment would have made a profit of $100 if you invested in the shares of XYZ but it would have made a profit of $1,000 if you invested in Call Options of XYZ!

Leverage makes it possible to make a lot more profit on your investment than just by buying the underlying value (in this case the stock). However, it comes with a greater risk. If the investment moves against the investor, his or her loss will also be greater than it would have been if the investor had invested in the underlying stock.


Limited risk and unlimited potential profit

Unlike other leveraged investment vehicles as futures, Options Trading has a limited risk and unlimited potential profit as long as you limit yourself to the simple Call and Put Options like we do. That is to say that the maximum loss is limited to the premium paid for the Option and therefore is known at the outset.


Low initial capital

Unlike other leveraged investment vehicles as futures, you can already start trading Options with an amount as low as $100 and even lower. To start trading futures for example, you would be required to put several $1,000 on an account and sometimes even a lot more if you would like to 'go overnight' with the contracts. And if the market moves against you, there's always a risk to get a "margin call" from your broker forcing you to deposit additional money on your account or to sell off some of your contracts.

So trading options is not only for the rich and wealthy or the professionals. It's accessible for a much larger public.


Profit potential in bull AND bear markets (up & down)

Whether the market goes up or down, with options it's always possible to make money. If you think the market will go up, you buy a call option and if you think the market will go down, you buy a put option. With options it's even possible to make money when the market goes sideways but such strategies are out of the scope of this introduction to options trading.



What are options?

Introduction

An option gives the buyer the right, but not the obligation, to buy or sell an underlying asset (the stock for example) at a specific price on or before a specific date.

You can find examples of options in our everyday life.

Let's say for example, one day you are walking with your dog and you see a house for sale that you really like. At that moment you don't have the money to buy it, but you will have it in six months. You talk with the owner and you agree to pay $5,000 for an option to buy the house in 6 months for a price of $300,000. Two months later an oil well is discovered next to that house and the market value of the house rises to $900,000. Since the owner sold you the option, you still have the right to buy the house from him for $300,000 and of course you will buy it for that price! Finally you make a profit of $595,000 ($900,000-$300,000-$5,000). Let's say now that instead of an oil well next to the house, a heavy ground pollution is found and the market value of the house drops to $50.000. Of course you aren't interested in the house anymore! Because you bought an option, you aren't compelled to go through with the sale. In this case you just lose the $5,000 you paid for the option instead of a much bigger amount if you would have bought the house.

We work with stock options and index options but the principle is the same.


Calls and Puts

Options fall into two categories: Calls and Puts.

A call option gives the holder the right, but not the obligation, to buy the underlying stock at a fixed price (the strike price) and for a preset period of time.

A put option gives the holder the right, but not the obligation, to sell the underlying stock for a fixed price (the strike price) and for a preset period of time.

In case of index options, the holder participates in the movement of the index. These options are cash-settled, so the holder will never wind up with a position in the underlying asset.


Options strategies

Although there are a lot of options strategies, benefiting from a stock price's rise, fall or sideways action, we will only discuss 2 of them, the long call and the long put. These two strategies, the most commonly used, are the easiest to understand and have a limited risk and unlimited potential profit.





The expiration process

Options have an expiration date. This date is indicated by a month and year description. The expiration date is the last day an option exists. Most options traders (like us) don't wait until that date to resell the options they have bought.


Exercising an option

Options traders don't actually have to buy or sell the underlying shares that are associated with their options. As a matter of fact most of them (like us) simply opt to resell their options. If they however do choose to purchase or sell the underlying shares represented by their options, this is called exercising the option.


Options pricing

The factors that affect an options price the most are:

• The underlying stock price
• Time Value (The length of time until expiration)
• Volatility (how much the price fluctuates)

Now, you're ready to take a look at our options trading system in how it works.

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