Options Trading Tutorial: Learn How to Trade Options
So what have we learned?
So now that we have a basic understanding of how to buy options. Lets discuss how we can realize profits from trading options. Once you have purchased an option:
Lets say you purchased the $825 call. Now let's assume within two weeks time the price of April Gold has risen to $825. How much have we profited from this move? We know that since the commodity price has risen closer to our strike price, our intrinsic value has increased, and we also know that we have lost two weeks of time value. In relation to time value, we technically have 4 months until expiration, and two weeks out of four months isn't too great of a loss. In relation to intrinsic value, we know that the initial $800 call option we looked at was valued at $8,000 when it was 'at-the-money' (meaning the strike price and current market price were equal). So now that the current market price of April Gold has reached the same value of our strike price at $825, we can make the assumption that the value of our option is roughly $8,000 minus the two weeks worth of time value. The exchanges use an algorithm to calculate this value, yet we can only make an assumption at the value. So within two weeks time we have made a profit of $5,000 minus the two weeks time value we lost. We can enter an order to offset our position to realize profits. Progressively, if it took two months to reach $825, we would make an assumption that maybe the amount gained in intrinsic value has been offset by the amount of time value we have lost, and our trade might be even. Furthermore, if it takes four months to reach $825, we can be pretty certain that the value of the option is near $0 due to the fact that there simply isn't anymore time left.
Now lets continue with the preceding example, and say upon expiration the price of April Gold is now $900/oz. We have realized a profit of (900-825) $75/oz per 100 ounces. $7,500 minus our initial $3,000 investment leaves us with a net profit of $4,500. Prior to expiration, we can offset this position to lock in profits. Or we can leave the position into expiration, at which point we would be assigned a net long position in April Gold futures. Keep in mind, since we purchased a call option, we are assigned a long position. Had we purchased a put option, we would be assigned a short position if the price had decreased and we were 'in-the-money'(meaning the market price had surpassed our target strike price). Now that we have been assigned a futures position, we must be aware of the additional margin requirement needed to hold onto such a position. We would be assigned a net long position at $825 when the market price is $900, and we can continue to ride the futures position.
*Note: all examples used did not account for commission and brokerage fees. Costs are associated with all transactions, and should be accounted for.
Selling Options, also known as 'writing' options is a way to profit by predicting where a market will not go. Some individuals assume it is a lot easier to make this type of prediction, in addition to the various strategies available to lower your risk when writing options.
To learn more about selling options, feel free to contact any one of our qualified brokers and we will be happy to provide you with further information.
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* The information provided here is purely educational, Expo Futures will not be held responsible for either its accuracy or completeness. There is a risk of loss in trading options. Trading options is not suitable for everyone. Past performance is not indicative of future results.