Options Trading Types

Option trading today has probably become the most popular form of trading and we see the continuous surge of new traders entering this market. Although a little complex than the simple stock trading, option trading has the potential to bring in huge profits but at the same time, not to forget, huge losses if things do not go the predicted way. Therefore with calculated risks, traders can reap in profits if they have the complete knowledge and understanding of the option trading market. Here we would discuss the various types of option trading.

Types of options

The financial options are basically divided into these categories:

  1. Exchange traded options: also known as listed options, they have standardized contracts which are settled through a clearing house. The guarantee of fulfillment is provided by the exchange. The various types of exchange traded options are stock options, index options, future options, bond options and other interest rate options.
  2. Over-the-counter options: these options are not listed on the exchange and are also known as dealer options. They are traded between two private traders and the terms of contract here are unrestricted and may be made as per the business need.
  3. Employee stock options: these are options that are issued to the employees by their company as compensation.

Option trading is carried in two basic ways. These are the

  • The call option
  • The put option

The Call Option

The right to buy the underlying asset or security at a certain price either on or before a specific date is referred to as the call option. A trader buys a call option in anticipation of the rise of the price of the stock or the underlying security before the expiry of the option. If the anticipation of the trader is correct above the movement of price of the security, he could buy the option and then sell them immediately to make a profit. Trading the option without actual buying can also be done.

The Put Option

The put option is the trader’s right to sell the underlying stock or security at a certain price either on or before a specific date. A trader buys a put option in anticipation of the falling of the price of the stock or the underlying security before the expiry period.

All the below mentioned exchange traded options have call and put options in them. We would now discuss these exchange traded options.

The types of exchange traded options

Index options: an index option is also called a stock index option. An index option gives the trader the right to trade a specific stock index at a certain price on or before a certain specific date. A call option on an index option gives the right to the trader to buy the index whereas the put option gives the right to the trader to sell the index option. The profit or loss on an index option depends on the price at the close of the market at the end of the day and not on the price during the time when the market is open. In this regard index options are different from Exchange Traded Funds whose values keep changing throughout the day. If a trader exercises his option before the end of the day and the market close, the trader would have to give an additional amount that is equal to the difference between the exercise price and the closing price.

Future options: a futures option is a contract to buy or sell a specified commodity or asset at a predetermined date in the future and at a predetermined price or the future price. They are a type of derivative contract and are not direct securities like bonds, warrants, stocks or rights. The prices of the future option are determined by the instant balance between the forces of demand and supply among the competing traders or buy and sell orders on the exchange when the sale or purchase contracts are made. The underlying assets in the future options are currencies, financial instruments, securities or other intangible assets such as interest rates or stock indexes. Future options are generally traded by hedgers that seek to hedge out their risk of price changes and the speculators that seek to gain by predicting the market movement. A call option here is the option to buy a future contract whereas a put option here is the option to sell a futures contract.

Stock options: this is the privilege under which the buyer has the right but not the obligation to buy or sell a stock at a predetermined price within a specific period or on a specific date. These are simple contracts that allow the traders to call or put or alternatively buy or sell a stock at a specific price before the expiry. The stock options have become the most versatile and popular hedging and speculative instrument for the traders.

Conclusion

These are the various types of options available but they are not for the beginners. As advanced tools of investments they provide the traders the versatility they need to trade.

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