If you are looking for ways to diversify your portfolio, or of making a profit in the market, trading options is a good alternative to explore. This is because options can offer a less risky option when compared to equities, have the potential to generate higher returns than other investment alternatives, and they generally provide better cost efficiency to investors.
However, before you reap the benefits of options trading online in Singapore, there are a few basics that you need to learn as far as trading these derivatives is concerned. Here is what you should know about how to trade options and how you can make money doing it.
Options are derivatives, which means that they feature an underlying asset. This asset can be a commodity, currency, or a stock. And so options trading involves trading in the rights to buy or sell the underlying asset.
Call Options
With a call option, the holder or the buyer of the asset acquires the right to purchase the asset at a given price before time runs out. However, unlike when trading with futures, this only confers the right to buy, but it is not an obligation.
Therefore, if you are a buyer of a call option, you are essentially implying that you think that the price of the underlying asset will eventually be higher than the price that it has been agreed on. You are also betting that the asset will attain a higher price before the expiry of the option.
As a result, you will be buying the option at the given price, which is called a strike price, hoping that you will sell it once the asset gets to a higher price. Therefore, if this happens, you will be able to resell the underlying asset at a profit, since you had initially bought it at a lower price.
To be able to make this bet, you will need to pay the seller a fee. This fee, usually referred to as a premium, is also the maximum amount that you stand to lose on the deal.
As for the seller of a call option, they are generally of the view that the price won’t increase beyond the strike price, at least not before the expiry of the option. As a result, to the seller, the premium that they get at the outset is generally the profit that they are hoping to make.
Put options
On the other hand, buying a put option simply means that you think that the price of the underlying asset will fall below the strike price within a given date. Therefore, as a buyer of the option, you gain the right to sell it at the set price, provided you do so within a certain period. Therefore, if you are looking to make a profit, you will buy put options of underlying assets whose price, you believe, will fall before a given date. Essentially, you will be buying the underlying asset at the lower price.
For the put seller, they will make a trade when they believe that the price won’t fall below the set price. And as soon as they sell, they immediately receive an upfront amount that is called a premium. As a result, if the price ends up falling below the set price, then they will be under an obligation to buy the underlying asset at the set price.
Therefore, this means that as a trader, you basically have four trading options. You can choose to be a buyer of either put options or call options. You can also choose to be a seller of either put options or call options. And while there may be a few more details and processes that you have to familiarize yourself with, these are the basics of trading options. In short, options trades essentially involve betting on whether the market price of an underlying asset will increase or decrease within a certain period.