Options Trading for Beginners
What are Options?
An option is a contract through which one party grants to another the right, but not the obligation, to buy or sell an asset at a specified price, called the strike, by a defined date in the future, called the expiration. Traders choose between call options and put options, which allow them to buy or sell the underlying asset, while the seller must fulfill the obligation, if exercised.
Let’s break that down:
- Call Option - A contract that gives its purchaser the ability to buy the underlying asset at the strike price prior to expiration; call option buyers profit from price increases.
- Put Option - A contract that gives its purchaser the ability to sell the underlying asset at the strike price prior to expiration; put option buyers profit from price declines.
- Strike Price - The price at which the underlying asset may be purchased or sold for any option.
- Date - The date, or expiration, is a predetermined date and time when the option settles to the underlying asset or cash. Small Exchange® options settle to the underlying futures contract, which is then cash-settled .
- Quantity - The amount of the underlying market the option contract controls; most equity options are on 100 shares while options on futures tend to hold 1 futures contract.
Options allow their buyers and sellers to profit from movement in the underlying asset. As opposed to the simple buy or sell order in a given market, call options can profit from upside movement in the underlying relative to the strike price, while put options can profit from downside movement in the same manner.
- American Style Options - This option type allows holders to exercise their rights at any time prior to the expiration date. Small Exchange options are American style and can be exercised by giving notices of the exercise to the Options Clearing Corporation during Exchange market hours, prior to the day of the options expiration. Option exercise will result in a position in the underlying futures contract.
- In-the-Money - An option that has a strike price that is lower (in the case of a call option) or higher (in the case of a put option) than the price of the underlying futures contract for that option. Small Exchange option contracts that are +1 in-the-money will be automatically exercised at expiration.
- Out-the-Money - An option that has a strike price that is higher (in the case of a call option) or lower (in the case of a put option) than the price of the underlying futures contract for that option.
- At-the-Money - A call or put option which has a strike price that is the same as the price of the underlying futures contract.
Types of Options Markets
Options can be traded on many stocks, futures, and indexes, allowing you to trade the underlying market in a different way.
Options on futures operate very similarly to stock options, but the two types differ in the underlying asset they represent. Options on futures offer the same unique opportunities but on a futures contract as opposed to shares of stock. They are particularly intriguing given that the futures that they follow can track hard-to-reach assets like commodities and cryptocurrencies. With options on futures, you can access countless call and put strikes on everything from crude oil to Bitcoin with ease and low costs.
Common assets traded as futures contracts include:
The Small Exchange is offering options on certain futures markets to further the everyday trader’s access to these markets. Small futures allow smaller accounts to gain long and short exposure in stocks, bonds, commodities, and other access classes, and Small options on futures give even greater access to markets by letting traders further small-ify position sizes.
Small Precious Metals futures, which feature components gold, silver, and platinum, are the first Small Exchange futures to offer options. In an effort to provide its users with as many strategic advantages as possible, the Small Exchange aims to include options on other futures markets and those still to come.
Find an Options Broker
To access Small Exchange futures, you will need a futures trading account. Choose a broker that fits your investing needs. While reviewing firms, some items to consider: Does the firm offer easy-to-use technology (trading platform and application)? Are the commissions and fees competitive? Does the firm offer the markets you would like to trade?
Once your account is open and futures enabled, you’re ready to start trading the Smalls! Simply search the symbol for the market you wish to trade, and send a buy or sell order following your opinion of the market. Trading platforms may use different symbols than the exchange, so be sure to use the symbology specific to your broker.
How to Choose Your Options Trading Strategy
Options on futures operate nearly the same as stock or index options save for the underlying asset being futures, so option traders who have developed strategies in those other product types should feel comfortable translating them to options on futures.
Those who are new to options can get started with one of these simple strategies:
- Long Call Option - gives the purchaser the right, but not the obligation, to buy the underlying future at a strike price in the future; buying a call option results in a bullish position. Purchasing in-the-money calls has a higher probability of success and usually a high cost; purchasing out-the-money calls has a lower probability and usually a lower cost; and purchasing at-the-money calls has a 50/50 probability and usually a medium cost.
- Long Put Option - gives the purchaser the right, but not the obligation, to sell the underlying future at a strike price in the future; buying a put option results in a bearish position. Purchasing in-the-money puts has a higher probability of success and usually a higher cost; purchasing out-the-money puts has a lower probability and usually a lower cost; and purchasing at-the-money puts has a 50/50 probability and usually a medium cost.
- Short Call Option - obligates the seller to sell the underlying future at the strike price, if the call is exercised by the buyer; selling a call option results in a bearish position. Selling in-the-money calls has a lower probability of success and usually a higher potential profit; selling out-the-money calls has a higher probability and usually a lower potential profit; and selling at-the-money calls has a 50/50 probability and usually a medium potential profit.
- Short Put Option - obligates the seller to purchase the underlying future at the strike price, if the put is exercised by the buyer; selling a put option results in a bullish position. Selling in-the-money puts has a lower probability of success and usually a higher potential profit; selling out-the-money puts has a higher probability and usually a lower potential profit; and selling at-the-money puts has a 50/50 probability and usually a medium potential profit.
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