OPTIONS TRADING

Looking to trade options? We explain the principles and how you can trade them.

What is an Option?

A type of derivative, an option is a financial instrument that allows you to trade on the future position of an underlying market. It offers you the right, but not the obligation to buy (a call option) or sell (a put option) to trade a market in the future at a set price.

Trading gold with options

Let's look at trading gold as an example. It's a commodity that you'd like to sell at the highest possible rate and buy at the cheapest.

The current underlying price of gold is $1200 per ounce, and you think it is set to rise. You'd like to buy it at or around the same price. So you decide to purchase an option to trade gold at $1210 (a Call Option). It offers you the right, but not the obligation, to buy it at $1210, on or before a certain expiry time.

This level is referred as your 'strike price' - the premium you've paid for the option.

If the price of gold increases and reaches $1300 per ounce, your option to buy gold at $1210 (a much lower price than the current market value) will be attractive as you'll be able to sell the option or buy the gold at a cheaper rate for a profit.

However, if the price of gold was to go down to $1150 (when your option expires) it would be worthless. Your right to buy gold at $1210 would be of no value as no one would want to buy gold at a higher price than the current market level. You would therefore lose the premium you paid. If you have a longer-term option though, you could retain it and hope the underlying price moves back in your favour, before it expires.

Options can be a highly effective tool, particularly when markets are volatile. They allow you to essentially trade on future volatility itself.

It's important to know that you are not physically selling or buying an option and that it can never be exercised. You are trading on the value of the option.

How it works

There are several factors that will impact the price of an option:

• the level of the underlying market compared to the strike price
• the time the option has left to expiry
• the underlying volatility of the market

CFD trading options are split into two: Puts and Calls

• A put option is the right to sell an underlying instrument at a certain price
• A call option is the right to buy an underlying instrument at a certain price

You can find out more about the types of options available.

Learn more about options

To find out more, take a look at our options examples, or view our seminar for the basics and some simple options dealing strategies.

You can also find explanations for some of the terms used in our trading glossary.

http://www.igmarkets.com.au/cfd/options.html