Options and options trading: the basics

Call and Put Options​

There are two types of options; let’s learn about them to better understand how they can be used.

What is a Call Option?

A call option gives the option to buy the underlying asset at a certain price and according to certain deadlines. The buyer will then have the option to proceed by a certain date.

Buying an option is useful if you think the price will go up over the life of the contract. By subscribing to a call option priced at $100, if at expiration the underlying had reached $130, we would exercise the right and take home a handsome profit.

What about the seller? This figure is “at the mercy” of the buyer and would have an obligation to sell if necessary. However, the person who sells a call option does so because he or she expects the market to go in the opposite direction from a buyer’s expectations; taking our example again, the seller would have seen it right if the price went below $100.

What is a Put Option?

Instead, this type of option gives the holder the right to sell the underlying asset at a given price and until expiration. Exercise of the option will occur only if the price of the underlying asset is below the strike price (because the option would grant the holder the right to sell at a higher market price). The profit is the difference between strike and market price, from which the premium must also be subtracted.

As with calls, puts bring together two sides with opposite views on the market.

"Call or put options? You can both have the right to buy and the right to sell"

Options expiration

Depending on the contract and the type of option, they can be exercised by a certain date or on a specific date.

If the holder of the right decides not to exercise it, nothing happens when it expires.

In the event that the option is exercised, the counterparty must comply with the terms of the contract and honor its obligations. For example, it may be necessary to pay money to the person exercising the option (in case the option is based on an index); or it may be necessary to sell or buy the underlying asset(s).

Being a contract, the option regulates in detail how it operates and leaves no room for interpretation.

Options trading: how to do it?

Operating with options is not for everyone. The reason is simple: being derivatives, the complexity of these instruments rises quite a bit and could be confusing.

If we think about buying and selling stocks, everything is simpler: we just buy and sell, we don’t have to worry about anything else. Of course, we will have to set a stop loss, maybe even a take profit, but in itself the instrument is not complicated.

With derivatives everything changes. Options contain several variables and also involve a more in-depth study of the underlyings. One also has to make precise calculations to assess whether actually, after deducting the premium and any fees, the potential profit is worth it.

If one has the right experience, these financial products are very useful for adopting more complex operating strategies, maximizing gains and hedging against losses. It is precisely this last point that makes them so attractive and traded, but woe betide you if you underestimate them.

In case you were a novice or moderately experienced investor, these products would not be the best financial instrument to choose from. If, on the other hand, you already had good experience and knowledge, you may have found another interesting tool to add to your toolbox.

"Operare con le opzioni non è da tutti: servono conoscenze ed esperienza"

Binary options

Let us open a parenthesis on a product that is widespread among the uninitiated: binary options.

Let us not be fooled by the name: although they are called that, they have nothing to do with those seen so far.

Binary options put “the investor” in front of a simple choice: to say whether an asset will go up or down at expiration. Here is an example of a binary option:

• Asset: Tesla stock
• Expiration: 10 minutes
• Gain: 80%.

Let’s say we “invest” 100 euros on this binary option, opting to go up. If after 10 minutes the price is actually higher than the starting price, we will have won 80€, or 80% of the “invested capital” (100€). If, on the other hand, the price has fallen, the entire amount wagered will go up in smoke.

We put every reference to the investment in quotation marks. The reason? As you have certainly guessed, binary options are real bets. What difference does it make between saying who will win between the Lakers and Bulls? Absolutely nothing. And just as with sports betting, the end results are the same:

• If you are wrong you lose everything
• If you are right you win the odds

The platforms that offered the opportunity to trade these products made quite a lot of money from customers’ losses, while very few were lucky enough to pocket some profit.

For some years now, binary options have been banned in Europe at the behest of the European supervisory authority (ESMA). Let’s add “fortunately”: some binary options, called turbo, super and the like, lasted very few seconds; “investors” were under the illusion that they could do technical analysis with 5-second Japanese candlesticks, an absurd thing for one of the most complex and analytical activities that exist.

Options risks and benefits

Let’s go back to real financial options and understand their risks and benefits.

The risk is that of so many other products and assets: losing money in case we were wrong, nothing simpler.

The benefits, in addition to the possible gain, lie in the ability to hedge and incorporate options into a broader investment strategy.

We recommend caution before trading in these financial instruments. We recommend that you study options, gain experience with small amounts, and only then integrate them into your investment strategy.