Derivatives are a new trend in financial markets that have enabled traders and investors to have a better experience with trading. First, you should try to understand what derivatives are. Derivatives are the financial instruments that derive their value from underlying assets like equity, commodity, index, etc.
Derivatives are shock absorbers during volatile market conditions with ups or downs. Options contracts are among the derivatives with high preference among traders and investors. The main reason for their preference is their ability to offer trading opportunities. However, traders and investors must understand options to trade proficiently and thoroughly.
Fundamentals of Options Trading
Options are contracts that provide traders the right but not the obligation to buy or sell a specific quantity of underlying assets at the predetermined price and date. Traders can trade these over the counter or through live public markets through standardized contracts. These are some of the terminologies widely used in options trading:-
- Call Options: These options provide traders the right to buy.
- Put Options: Put are the option contracts that provide traders the right to sell an asset at a specific price and date.
- Strike Price: The price at which an option contract can be bought or sold.
- Premium: It is the price traders pay to purchase the options. Factors like underlying stock price, volatility in the market, and the days until the option’s expiration determine the premium a buyer needs to pay.
Different Options Greeks
Option Greeks are metrics that traders use to determine the effect of certain factors on the price movements of options. These are some most common options Greek that traders must know of:-
- Delta: It is an option Greek that enables traders and investors to measure the change in option value at one point in the price of an underlying asset. It varies from zero to one for call options. However, for put options, it ranges from -1 to zero. Delta changes with the underlying fluctuation and represents the percentage of participation in underlying movements. Delta favors a trader for long positions when the price appreciates, providing dynamic leverage to traders. However, for short positions, the decreasing price of the underlying goes in favor of traders.
- Theta: Theta provides the insight to measure the change in options premium within 24 hours.
- Vega: With Vega, traders can measure the one-point change in the underlying asset’s implied volatility.
- Gama: It provides the measurement of the change of delta with the change of price of an asset.
- Rho: It is the delta that measures the change in the option’s premium to one point change in interest rate.
Perks of Trading With Options
These are the perks that option trading offers that make it a compelling choice for traders and investors:-
- Trading Portfolio: Traders can go for multiple markets and assets using options like options on metals, stocks, indices, etc. The same creates a higher chance of finding trading opportunities to make speculation. It also develops a better cognizance of the global marketplace and evolves the decision-making process employed by traders and investors. With the same, traders can trade more rationally in the future.
- Lesser Requirement of Investment: Traders must pay a premium to hold option contracts. It is much less than the price of assets. It contributes to lesser investment in comparison to the actual value of the asset as per the lot size. With the same investment, traders can speculate on higher volume with options.
- Liquidity: Options are a high transaction market that offers ease of trading. Traders can easily buy or sell in the options market, enabling traders to make a trading decision per their strategy or convenience and have favorable outcomes.
Options are derivatives with high preference among traders and investors for their ability to offer trading opportunities. Option Greeks are metrics that provide a trader the insight to measure certain things’ impact on an option’s price. Trading involves risk and can result in losses exceeding deposits. It is essential to ensure traders understand the risks and manage their exposure.