» Futures & Options
Options are derivatives contracts that give the buyer the right to buy or sell an underlying asset at a certain price within a specified time period. Selling or buying options involves two parties, namely a buyer and a seller. The strategy of selling options is popular mostly with traders who are capable of managing the element of risk that is inherent in such transactions.
How do Options Work?
Options trading involves understanding market conditions and predicting where the markets are headed. So, when a trader believes that an asset will appreciate in the future, he/she is likely to buy the asset at a premium value.
The instrument that gives an options holder this right to buy the underlying asset is called a call option. While the buyer of an option has the right to buy (call) the asset on the specified date, he/she is not obliged to do so. However, the seller of the option is obliged to sell the underlying asset when the buyer of the contract wishes to exercise the option.
A put option gives the buyer the right to sell the asset before the predetermined date. The buyer exercises this option if s/he believes that the price of the asset will fall before the expiry of the call options.
Options are particularly used for:
- Speculation: Buyers speculate on the extent of price movement in a financial instrument over a specific period.
- Hedging: You can use options to hedge your investments or business contracts against a possible downside.
Types of Options
The various types of options include:
- Exchange traded options: These options have standard contracts that are settled through clearing houses. Some of the exchange traded options include stock options, bond options and options in futures contracts.
- Over-the-counter options: These options are contracts between two private parties. Some of the OTC options are interest rate options and currency cross rate options.
Benefits of Options
In options trading, you can make profits whether the market is falling or moving sideways.
Risks Related to Options
The options market is highly volatile and impacted significantly by speculation.
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