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Options Trading Online

Options Trading Online

Options trading: what is options trading?

Options trading and futures trading both fall under an umbrella known as derivatives trading. The main difference between the two lies in the fact that a future must be exercised, whereas with an option you have a choice as to whether to exercise or not. In other words, the holder of an option has the right to buy or sell the asset underlying an options contract, whereas the holder of a future is obligated to do so as soon as the future expires.

An option can be defined as a contract that confers a right rather than an obligation to sell or buy an asset at a specified price on or before a particular date. An option to sell is known as a put option, whereas an option to buy is termed a call option. The person selling an option is called the writer, while the person who has the right to buy the option is known as the holder. The buyer has a choice as to whether or not to exercise the option on or before it expires whereas the writer has an obligation to take or make delivery on or before the date the option expires.

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The price paid for the right to choose whether or not to exercise an option is termed the premium price. This price is different to the strike price which is the price that an option may be exercised at if the option holder decides to exercise his option i.e. the price the asset is eventually bought or sold for.

If on the date of expiry shares are trading above the agreed strike price, the holder will more than likely exercise their option. This will result in a loss for the writer.

By contrast, if shares are trading at a lower price than the agreed strike price on the date of expiry of the option, the holder will probably not exercise his option. The holder will then lose the amount that he paid for the option i.e. the premium price.

There are two main types of options contracts in options trading. A European option can only be used on the day that it expires, whereas an American option can come into effect before it expires and can be used up until and on its expiry date. Since American options grant holders extra freedom, they are usually more expensive then European options, or in trading terms you will pay a higher premium for an American option than a European option. In every scenario, writer's gain will be holder's loss and vice versa.

Like futures, the options trading market also embraces commodities such as oil, gas, copper, gold, wheat and sugar. Options are also available on financial products such as bonds, interest rates and currencies. Popular financial options include options on the FTSE 100 Index and the German Bund. In rare cases, options can also be held or written on unusual things such as sports games, political results and the weather.