Introduction to Option Trading


What is an option? An option is an agreement giving to the purchaser the RIGHT to purchase or sell a certain amount of a given asset at a certain moment. Differing from futures trading, in that,  option buyer does NOT have to execute the transaction (either purchasing or selling) at the exercise cost – he will do that when there it is profitable to him; if the option is let to expire, then the buyer will lose only the original money used to buy the option.

Most people hear that options trading is very risky and many people lose all their money trading options. However many other people make money with different trading options such as royal dutch shell, requiring little effort. Is it luck? Not likely… What is it then?

There are techniques to analyze options. An investigation of the revenue and loss according to selected policies. The answer, as too many things in life, is information.

The first thing one must do is to get information and understand globally the market that interests us and then narrow down the research to the area that most fits us and our needs. It is still risky but education is a very big step towards making much better choices.

Then after finding the market segment one wishes to trade in, one needs to learn everything one can, about it so as to be able to develop some strategies to try and get constant profits. It is relevant to point out that there is no wrong strategy to go about your trading, just as there is no right one. What matters is that you are comfortable with it and use it at the correct time to attain a  profit.

No strategy will work all the time because the conditions of the market change all the time, which can be adverse to the performance of your strategy so when conditions change one just needs to apply a new strategy.

One of the advantages of trading in the options market is that it requires a lesser amount of starting capital as using options for leverage is a nice strategy to attain a good return.

It is however important to notice that there are different kinds of risks in this market, such as the “Pin risk”, which arises when the underlying asset closes close to the strike value of the option just before the option expires. So the seller does not know if the option will be actually exercised or allowed to expire and may thus end up with a residual position when the markets open the next day. There is also the “counter-party risk” which is the risk of the seller of the option failing to buy or sell the asset as agreed.