Introduction to Vanilla Options
Congratulations! You have decided to learn about options and our goal at easyMarkets is to make learning about options both interesting and easy.
Did you know options are another way to trade the markets but they empower a trader to do a lot more than follow price direction?
What is an option?
An option is a contract sold by one party (the writer) to another party (the holder). The contract offers the buyer the right, but not the obligation, to buy or sell a financial asset at an agreed upon price in the future. The financial asset in our case is the currency or commodity.
Option contracts can be described as an insurance policy to insure the future price of a financial asset and, similar to an insurance policy, the buyer has to pay the seller a premium. Premium is the value of an option contract.
Today, you are exposed to options in many aspects of your life and you may not even realise it! Here are some examples:
- Have you ever paid a membership fee to a club or store just to receive lower prices on goods? You were sold an option which gives you the right to buy an amount of goods at a certain price over a certain duration and when you execute it you receive your goods at a lower price. If you don’t use your option, the store charges you full price for the goods purchased.
- If you want to buy something in the future, like a house, and want the ability to buy it without competing against others, you are buying the option (or the right to buy, but not the obligation) when you place money down. You would lose the initial investment if you chose not to buy the asset, or in this case the house, in the future. Alternatively, you may gain in this example if prices rise and you can buy the asset, or house, at a lower price.
- Companies, in which you purchase products from, are trading options to hedge their costs, e.g. Jewellers have to purchase gold often and they may secure future prices, eliminating risk, through buying options.
The above examples use tangible assets and it is much easier to imagine buying and selling physical assets. With Over-the-Counter trading (electronic trading), you will be trading intangible assets since you will never actually receive the goods you are buying or selling.
Get some Good reasons to trade vanilla options without the need to get your hands on physical assets.