There are many different financial instruments that investors can trade with today. Access the trading instruments is easy for any trader as trading takes place online. Out of the many possibilities that are available to traders such as stocks, bond, mutual funds and futures options play an important role. Options can be either conservative or speculative providing the investor with many opportunities for making profits. An investor can use options to perform many types of different investments that can start from protecting a position to outright trading in the market or index movements.
Options are all about handling risk. They can be complex or they can be simple. However, it is imperative that investors learn about options before trading in them and trading is recommended only with capital that can be risked for this purpose. A person who purchases an option is referred to as the buyer while the other party is known as the writer. An option can be either a call option or a put option. If you buy a call option you will be able to buy the underlying asset at the strike price anytime within the lifetime of the option. If it is a put option the trader will be able to sell the underlying asset at the strike price on or before the expiration date. This type of simple options and straightforward options are called Vanilla options. Options can be more complex as other variations of this financial instrument will show. These are called exotic options, as we have the exotic currencies in the forex market.
All options can be categorized into two main types. They are European Options and American Options. The European Option differs from an American Option in that it can only be exercised at the end of the lifetime of the option at expiration and not prior to that. In the case of the American Options a trader is able to exercise the option anytime within the time period of the option and this type of options can be seen commonly traded on exchanges.
An option has an intrinsic value attached to it. This basically refers to the value of the option. Other important terms to understand are ‘in the money’, ‘out of the money’ and ‘at the money’. An option is said to be in the money when the asset value exceeds the strike price and when it is below the strike price it is out of the money. At the money refers to the point when it is equal to the strike price. One salient point to remember is that an option that is not exercised by the time of the expiration date will expire worthless and here the buyer will lose his premium and the seller will gain the premium.
Options are basically used to hedge or as a type of insurance in the financial markets. Traders often resort to option trading to protect their trades. In addition to this options are also traded for purely speculative purposes to profit from trading. Options are ideal as short term investments which are highly profitable.