Equity options today are hailed as one of the most successful financial products to be introduced in modern times. Options have proven to be superior and prudent investment tools offering you, the investor, flexibility, diversification and control in protecting your portfolio or in generating additional investment income. We hope you'll find this to be a helpful guide for learning how to trade options.
Options on futures contracts are exactly what the name implies, they give traders "options". They are capable of being used in nearly every commodity market scenario and with variable risk and reward profiles. Too many traders fail to tap the true potential and flexibility of option spreads due to their seemingly complex nature; however, things aren't always as they appear. We strongly believe that you owe it to yourself to overcome your fear of trading commodity options and open your mind to the possibilities.
Options trading may seem overwhelming, but they're easy to understand if you know a few key points. Investor portfolios are usually constructed with several asset classes. These may be stocks, bonds, ETFs, and even mutual funds. Options are another asset class, and when used correctly, they offer many advantages that trading stocks and ETFs alone cannot.
A long options trade is entered by buying an options contract and paying the premium to the options seller. If the market then moves in the desired direction, the options contract will come into profit (in the money). There are two different ways that an in the money option can be turned into realized profit. The first is to sell the contract (as with futures contracts) and keep the difference between the buying and selling prices as the profit. Selling an options contract to exit a long trade is safe because the sale is of an already owned contract.
For example: A steel manufacturer importing coal from Australia currently and in order to reduce the volatility of changes in prices he always hedges the coal purchases on a 3 monthly forward contract where he agrees with the seller on day one of financial quarter to supply coal at defined price irrespective of price movements during quarter. So in this case, the contract is forward/future and buyer has an intention to buy the goods and no intention of making profit from price changes.
However, for put options (right to sell), the opposite is true - with strike prices below the current share price being considered "out of the money" and vice versa. And, what's more important - any "out of the money" options (whether call or put options) are worthless at expiration (so you really want to have an "in the money" option when trading on the stock market).
Whether the economy is hot or not, an investor can make money trading commodity options, regardless of the condition of the market. Briefly, a commodity option allows its owner to either sell or buy a commodity like corn or wheat at a future date. You will buy a so-called “put option” if you think the price of the commodity will go down and a “call option” if you think the price will rise. And never will you have to take possession of the commodity itself.
The information contained in this article is provided for general informational purposes, and should not be construed as investment advice, tax advice, a solicitation or offer, or a recommendation to buy or sell any security. Ally Invest does not provide tax advice and does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances.
Combinations are trades constructed with both a call and a put. There is a special type of combination known as a “synthetic.” The point of a synthetic is to create an options position that behaves like an underlying asset, but without actually controlling the asset. Why not just buy the stock? Maybe some legal or regulatory reason restricts you from owning it. But you may be allowed to create a synthetic position using options.
The price at which you agree to buy the underlying security via the option is called the "strike price," and the fee you pay for buying that option contract is called the "premium." When determining the strike price, you are betting that the asset (typically a stock) will go up or down in price. The price you are paying for that bet is the premium, which is a percentage of the value of that asset.