WHAT ARE THE VANILLA OPTIONS?
Vanilla options are contracts that provide operators the right to buy or sell a specific amount of an instrument at a given price in a predefined time. When operating with vanilla options, the operator has the power to control not only the instrument and the amount it operates, but also when and at what price. The options can be operated in a day, in a week, in several months or even a year.
There are some unique terms in the stock market of vanilla options, and one must know them before starting to trade. There are two types of options – the purchase options that give the buyer the right to acquire an instrument at a specific price, and the sale options that provide the buyer with the right to sell the instrument at a specific price. Purchasing options are generally purchased by operators who believe that the market is on the rise, and are known as bullish or optimistic traders, while put options are acquired by operators who speculate a decline in the market , or the so-called bearish or pessimistic traders. However, one can both sell and buy all types of options.
In order to be an option holder, the buyer pays the seller an amount called a premium. When the operator acts as a buyer, he pays the premium, and when he sells an option, he receives it. The premium is decided by a series of factors; the first is the current type or price of the instrument. In addition, since the options are contracts that operate in the future, there is also the time factor. The date on which the option can be executed is called the expiration date, and the price at which the option buyer can choose to execute is the strike price. Longer-dated options have higher premiums than options with shorter dates, similar to the acquisition of insurance.
Another key factor in determining the premium is the volatility of the underlying instrument. High volatility increases the price of the option, since greater volatility means that there are more possibilities of large movements in the market that could provide benefits – potentially even before the option has reached the strike price. The operator can choose to close the position of this option on any trading day, benefiting from a higher premium, whether it has risen due to increasing volatility or market movement in that direction.
The following table demonstrates the impact of the prices of the purchase and sale options, if any of the key factors move upwards.
FUNDAMENTALS OF VANILLA OPERATIONS
When an option is purchased, whether for purchase or sale, the operator pays the premium in advance from the effective balance of his account, and his potential earnings are unlimited. When options are sold, however, the operator receives the advance payment of the premium in its effective balance, but is exposed to potentially unlimited losses if the market moves against this position, similar to the losses of a cash transaction. To limit this risk, traders can use “stoploss” orders in the options, as with cash transactions. Alternatively, the operator may acquire an option further away from capital, thus completely limiting its potential exposure to such losses.
When buying options, there is a limited risk; The most that can be lost is what was spent on the premium. When selling options – a perfect way to generate income – the operator acts as an insurance company, offering another person protection in the position. The premium is collected, and if the market reacts according to the speculation (investing and speculating), the operator will retain the benefits that he achieved by taking the risk. If it is wrong, it is not much more different than making a mistake in a regular cash operation. In any case, the operator is exposed to an unlimited decline, and therefore can close the position (with limit orders of losses, for example), but with the options the operator has won the premium, a real advantage over the operations cash.
The first step in stock options is to determine the market vision for the chosen instrument. If an operator believes that a certain instrument will rise, he can express this point of view through three modes. The first will be to acquire the instrument directly, that is, with a regular cash operation. The second is to acquire a purchase option. With this investment strategy, the most you can lose is the premium paid in advance. This position can be sold at any time. This is the surest way to express a bullish view of the market. The next way to proceed is to sell the put option. If the instrument is greater than the exercise price at its expiration time, the option will expire without value – but the operator will keep the full premium that was collected in advance.
WHY OPERATE WITH VANILLA OPTIONS?
There are many advantages that attract traders to stock options. After all, it is considered a fairly safe investment – in fact, for a buyer of options (a form of buying shares), they are much less risky than the transactions with the underlying asset. For a seller, the negative risks are also less than if you make a mistake in a spot transaction, since the option seller manages to establish the exercise price according to his appetite for risk, and the premium is earned by assuming said risk. risk. The options require, at the beginning, an investment of time to get to know the product.
Perhaps the most exclusive advantage of the options is that one can express almost any market perspective, by combining long and short-term buying and selling options (day trading). If the operator is pessimistic in relation to the USD / JPY but is not sure, you can purchase a put option for your target expiration date, sit down and relax. Whether the USD / JPY rises or falls tomorrow, he will be safe in his position until the expiration date.
If it turns out that you are correct, and the spot price is less than the strike price at least as the value of the premium, then you will get benefits.
Like all instruments, stock options have their potential risks and losses. However, there is a big difference between trading cash and trading options.
In spot transactions, the operator can only speculate in the market direction – up or down. With the options, on the other hand, you can execute a strategy based on multiple factors – the current price against the exercise price, time, market trends, appetite for risk and much more; that is, it has a much greater control of its portfolio and, therefore, more room for maneuver.