Trading in Options - Some Basics
Investors can make use of this trading as an alternative to buying specific stocks or shares on a securities exchange. This not only broadens an investor's range of investment choices, but also provides an opportunity for portfolio diversification. Investing in options makes it possible for investors to employ a wider range of investment strategies to fulfil their financial goals. The Partners at StoneHouse Capital often report on options traded on different securities exchanges. They have a keen knowledge of how this information can be used to the benefit of their clients.
What is a Tradable Option?
This, as a financial tool, is a contract between a buyer (known as the holder or taker) and a seller (writer). This contract specifies the quantity and class of the underlying asset(s) to be sold, the price (the strike price) of an option, and the date by which the option must be exercised (expiration, or exercise date) is also noted. The settlement terms by which the contract will be fulfilled are also specified, e.g. by the actual delivery of the asset(s) or exchange of money.
Over the Counter Options
Over The Counter (OTC) ones are also called dealer options. This kind of trade is not listed on a stock exchange because it is contracted between two private parties. One of the parties is usually well capitalised, e.g. a bank. The terms of an OTC option are not subject to any restrictions. It can be individually tailored to meet any business need. Commonly traded types OTC ones include:
o interest rate options
o currency cross rate options in forex trading
Exchange Traded Option
Exchange Traded Options (ETO) are also called listed options. They are traded on securities exchanges around the world, like the LSE, NYSE, JSE and ASX. As such, they are subject to greater control and regulation than OTC options. The underlying asset class of an ETO can include any of the following:
o shares or stock
o an exchange-traded fund (ETF)
o bond options
o interest rate options
o stock market index options
o options on futures contracts
Option Styles
A tradable one can be sold according to various styles. The style depends on the terms of the contract. Some styles are determined by when the taker can exercise his/her rights. Apart from the strike date, different styles allow different times when options may be exercised, such as:
o American options: An option taker can exercise the right to purchase an option on any trading day before expiry
o European options: The strike date is the only time when an option taker may exercise his/her right to buy the option
o Bermudan options: Preset dates are determined on which options may be exercised.
Other options styles are determined by how it's writer sets the price, e.g.
o Asian options: The strike price is determined by the average underlying price over a pre-set length of time
o Barrier options: A certain price barrier is set. The price of it must then break through this barrier for the taker to exercise his/her right to purchase
o Binary options: Certain conditions are set. If these are met in full they may be exercised. If not, it's is worth nothing
o Exotic options: This is a broad category of it that may include complex financial structures.
The Purchase of Options
Call Options
The buyer or taker of a one acquires the right to buy one at the strike price on, or before, the expiration date. However he/she is not obliged to do so. The writer receives a premium from the taker when he/she exercises this right and buys it.
Put Options
In the case of a one, the buyer or taker acquires the right to sell an it at the strike price on, or before, the expiration date. As in the case with call ones, there is no obligation to sell it. If this taker exercises his/her right to sell, he/she pays a premium to the writer for doing so.
Investing in this provides a flexible alternative to direct investment. While the benefits which can be reaped from this investment can be quite extensive, it comes with a certain amount of risk. This is a very good reason to consult a knowledgeable Certified Financial Planner ( CFP [http://www.stonehousecapital.co.za/What] ) or investment advisor like one of the Partners at StoneHouse Capital.
Investors can make use of this trading as an alternative to buying specific stocks or shares on a securities exchange. This not only broadens an investor's range of investment choices, but also provides an opportunity for portfolio diversification. Investing in options makes it possible for investors to employ a wider range of investment strategies to fulfil their financial goals. The Partners at StoneHouse Capital often report on options traded on different securities exchanges. They have a keen knowledge of how this information can be used to the benefit of their clients.
What is a Tradable Option?
This, as a financial tool, is a contract between a buyer (known as the holder or taker) and a seller (writer). This contract specifies the quantity and class of the underlying asset(s) to be sold, the price (the strike price) of an option, and the date by which the option must be exercised (expiration, or exercise date) is also noted. The settlement terms by which the contract will be fulfilled are also specified, e.g. by the actual delivery of the asset(s) or exchange of money.
Over the Counter Options
Over The Counter (OTC) ones are also called dealer options. This kind of trade is not listed on a stock exchange because it is contracted between two private parties. One of the parties is usually well capitalised, e.g. a bank. The terms of an OTC option are not subject to any restrictions. It can be individually tailored to meet any business need. Commonly traded types OTC ones include:
o interest rate options
o currency cross rate options in forex trading
Exchange Traded Option
Exchange Traded Options (ETO) are also called listed options. They are traded on securities exchanges around the world, like the LSE, NYSE, JSE and ASX. As such, they are subject to greater control and regulation than OTC options. The underlying asset class of an ETO can include any of the following:
o shares or stock
o an exchange-traded fund (ETF)
o bond options
o interest rate options
o stock market index options
o options on futures contracts
Option Styles
A tradable one can be sold according to various styles. The style depends on the terms of the contract. Some styles are determined by when the taker can exercise his/her rights. Apart from the strike date, different styles allow different times when options may be exercised, such as:
o American options: An option taker can exercise the right to purchase an option on any trading day before expiry
o European options: The strike date is the only time when an option taker may exercise his/her right to buy the option
o Bermudan options: Preset dates are determined on which options may be exercised.
Other options styles are determined by how it's writer sets the price, e.g.
o Asian options: The strike price is determined by the average underlying price over a pre-set length of time
o Barrier options: A certain price barrier is set. The price of it must then break through this barrier for the taker to exercise his/her right to purchase
o Binary options: Certain conditions are set. If these are met in full they may be exercised. If not, it's is worth nothing
o Exotic options: This is a broad category of it that may include complex financial structures.
The Purchase of Options
Call Options
The buyer or taker of a one acquires the right to buy one at the strike price on, or before, the expiration date. However he/she is not obliged to do so. The writer receives a premium from the taker when he/she exercises this right and buys it.
Put Options
In the case of a one, the buyer or taker acquires the right to sell an it at the strike price on, or before, the expiration date. As in the case with call ones, there is no obligation to sell it. If this taker exercises his/her right to sell, he/she pays a premium to the writer for doing so.
Investing in this provides a flexible alternative to direct investment. While the benefits which can be reaped from this investment can be quite extensive, it comes with a certain amount of risk. This is a very good reason to consult a knowledgeable Certified Financial Planner ( CFP [http://www.stonehousecapital.co.za/What] ) or investment advisor like one of the Partners at StoneHouse Capital.
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