Article / 21 April 2016 at 14:00 GMT

Do your homework before embarking on an options journey

Director, Europe / The Options Industry Council (OIC)
United Kingdom
  • Some investors see options as a mystical tool, which they are not
  • It pays to do research for options trades, as we do for an underlying security
  • Find out what call, put, exercise (strike) price, premium and expiration mean
  • Option trading is like a voyage of discovery

By Gary Delany

There is a lot of information available on using options as a hedging or investment tool. But sometimes it’s hard to see the forest for the trees.

As part of Saxo Bank’s ongoing webinar series that includes the Options Industry Council, we are doing a recap on some of the themes tackled so far before advancing to the next level.

It might be useful to offer some common sense comments on this theme.

1 Options are not magic

I say this a lot in seminars. There is a tendency among some investors to see options as a mystical tool. They are not. In just the same way as you would do your research if you were investing in the underlying security, you need to do it for an option trade.

Is the security trading in a tight range? Is it about to spike, up or down? Are you concerned about the impact of a sharp down move on your portfolio?


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 Option trading is like a voyage of exploration, because we know some but not all of what lies ahead, and there are plenty of tools available to help us find our way. Photo: iStock

2 How much do I know about options?

Of course the answer is ‘never enough’, but there are some core themes that you need to understand. Here’s a few of them.

  • Basic mechanics:  Do I understand the contract terms for an option trade – call, put, exercise (strike) price, premium, expiration etc? What is the right or obligation of the option buyer and the option seller? What does at, in, or out-of-the-money mean? Please see this site to learn more.
  • Choosing a strategy: What are some of the typical strategies that market users are employing for hedging or investment? Do I know how to work out the profit and loss of my position for various price outcomes? What’s my upside, and my downside? What is my personal risk profile like? What level of risk – and cost – am I happy with? Make sure you understand the strategy and its profit and loss implications. See here for more information.
  • Valuations: What ingredients influence an option’s price? What role is played by time to expiration, volatility, strike price, underlying price and interest rates.

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One approach for those starting out in options is to begin with the stocks you already
own and see what strategies might be used with them. Photo: iStock



3 What if there are gaps in my knowledge?

Serious option investors will already be familiar with most of the above questions. If you don’t know any of the answers, help is readily at hand on The Options Industry Council website or the Trading Floor website.

OIC’s Option Education Program offers the ability to learn online at your own pace. OIC’s focus is investor education, and the content is free and easy to digest. No salesman will call you. See here.

4 Practice helps

Accounts where you can paper trade are widely available. A couple are the virtual Trading System (VTS) on the OIC website or the Saxo Trader demo account.

Using the ‘quotes’ tool on the OIC website you can also search by an option’s name and view current price information (which is delayed by 15 minutes).

5 Do I have a plan?

We all hope that our strategy works out, but what if it doesn’t – what’s Plan B? Also, what are my exit plans: When do I plan to close the position? What’s my objective?

6 What practical choices do I have?

All investor profiles are different. One approach might be to start with the stocks that you already own and see what strategies might be used with them. For example, what happens if I write (sell) a call option on them?

And how can I buy cheaper protection if the market falls?

It’s been said 1,000 times, but options really do give investors options. Buying or selling calls. Or puts. Hedging or investing. A strategy involving just one option, or combined with another option, and/or an underlying security.

To summarise, option trading can be seen as a voyage of exploration, though it’s not necessarily suitable for everyone. We know some of the detail, but not all of it. Taking the first steps can be a challenge, but tools and knowledge exist to help us. It’s by questioning and experimenting that we grow our knowledge and skills.

For more information on the value and importance of the listed options markets, plus a comprehensive listing of OIC commissioned studies, please see the Options Industry Council.

– Edited by Adam Courtenay and Robert Ryan

Gary Delany is European director of the Options Industry Council (OIC)

For more information on OCC, see the fact sheet.

The Options Industry Council is an educational organisation funded by OCC, the world’s largest equity derivatives clearing organization, and the US options exchanges. The mission of OIC is to increase awareness, understanding and responsible use of exchange-listed options among a global audience of investors, including individuals, financial advisors and institutional managers, by providing independent and unbiased education combined with practical expertise. Learn more about OIC at www.OptionsEducation.org.

Disclaimers: The opinions expressed are the author’s own. Options involve risk and are not suitable for all investors. Individuals should not enter into Options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, which may be obtained from your broker, from any exchange on which options are traded or by visiting www.OptionsEducation.org. None of the information in this post should be construed as a recommendation to buy or sell a security or to provide investment advice. ©2016 The Options Industry Council. All rights reserved.

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Georgio Stoev Georgio Stoev
Good words of wisdom, Gary!
2y
zefy zefy
Great article. I have used options mostly protecting and hedging but like to learn more how to trade short term options (weekly FESX).

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