Online Options Trading
Online options trading has boomed to such an extent in recent years that fear has been expressed about a complete world banking crash should all option debts simultaneously be called in. As is the case with futures, trading in options is a risky form of online trading that should not be undertaken lightly.
Online options' trading typically takes on two forms - speculation and hedging. Speculation involves the opportunity to make large profits by risking huge losses. Speculators operate on the basis that if they can correctly speculate on the amount by which a stock is going to increase or decrease within a specific time frame, then they will be able to make money by buying stocks for less than they are worth and selling them for more than they are worth.
By contrast, hedging entails using options to your advantage to get the most out of fluctuating stocks, while simultaneously limiting your losses. Options writers usually sell options for more than they are worth and then hedge their position so as to avoid losses. Online options traders will typically be speculators rather than hedgers as there is more money to be made in speculating than there is in hedging.
There are four types of options trades: a call option sell, a call option buy, a put option sale and a put option buy. A buyer purchases a call (option to buy) in the hope that market prices will increase before the option expires. By contrast, buyers of puts (option to sell) enter into contracts in the hope that market prices will fall prior to expiry of the option. Buyers of puts and calls have no obligation to buy or sell-they have an option. Sellers of puts and calls are obliged to buy or sell should the holder wish to exercise his option. In relation to online options trading, traders will usually be the holders of call or put options rather than the writers of options. To realistically get a grip on the risks of online options trading, consider the following equations:
- You have $100 in your online trading account that you now want to spend.
- Lucrative online company X is selling shares at a price of 50c, which means that you can get 200 shares for your money. Call this scenario 1.
- Company X is also selling online call options with a strike price of $1 at a premium of 20c. If you chose this option you could get 500 calls for your money. Call this scenario 2.
- Say upon expiry of the call options company X had performed brilliantly and share prices had risen to $2. In scenario 1 you could sell your 200 shares at $2 each and make a profit of $300. In scenario 2 you could sell 500 options for the difference between the current price and the strike price which would be $1. In this scenario you would make a profit of $500.
- Now let's do the opposite and say that upon expiry of the call options shares in company X had risen, but only to 75c per share which is well below the strike price. In scenario 1 you would be able to sell 200 shares at a price of 75c and still make a profit of $50. In scenario 2 your option would be worthless upon expiry and you would suffer a loss of $100.
Like online futures trading, online options' trading is a gamble. The difference with regard to online options trading, however, lies in the fact that you will still have an option at the end of the day. While it is still better to open an account with an experienced e-broker, if you feel that you simply have to throw caution to the wind and become an online options trader, be aware of the risks. Learn the markets and keep an eye on your stocks at all time. Factors to remain particularly aware of include the date of expiry of the option, the price of market shares, the volatility of specific markets and current interest rates.