The current bear market has forced a lot of traders to search for other opportunities like Options trading, to hedge against the price declines that a lot of spot traders are seeing today. The last time we saw this level of activity in the Options market today was in 2021, when 9.92 billion contracts were traded, a record, according to data from The Options Clearing Corporation (OCC).
While you may have heard about the exponential amount of money you can make from trading Options, it is important that you have a sense of what exactly you are getting yourself and your money into before you begin this trading journey.
Options trading is how investors can speculate and predict, the future direction of the overall asset class they are trading such as stocks or cryptocurrencies. Options contracts give you the choice, but not the obligation, to buy or sell an underlying asset at a specified price by a specified date.
Stephen Callahan, vice president of client services at Firstrade, explained, “Options trading can be a great way to grow your income, limit your risk and hedge against market fluctuations at the same time.” How? Here’s what you need to know;
Options Trading Fundamentals
As previously mentioned, an Option is a contract giving the investor the right (or option) but not the obligation to buy or sell a specific asset class, at a specified price (also known as the “strike price”) for a specified period of time, ranging from days to years. When that specified time ends and the option expires, it no longer has value and no longer exists.
Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research gave a further description of what Options trading is really about by stating, “Unlike shares of stock, an option does not represent ownership in the underlying company. Because it’s a contract, it represents the potential for ownership, but it must be exercised to make that happen.”
It is important to know that there are two types of Options which are; calls and puts. Call Options give the holder (buyer) the right to buy a specified number of an asset class at the strike price, at any time until the contract expires. Put Options give the holder the right to sell a specified number of shares of an asset class, at the strike price, at any time until the contract expires.
When trading options, you are required to pay a premium upfront, which then gives you the option to buy an asset class, call options or sell the asset class, or put options, at the designated strike price by the expiration date.
What this means is a lower strike price has more intrinsic value for call options since the options contract lets you buy the asset at a lower price than what it’s trading for right now. If the asset’s price remains, your call options are in-the-money, and you can buy the stock at a discount.
Conversely, a higher strike price has more intrinsic value for put options because the contract allows you to sell the stock at a higher price than where it’s trading currently. Your options are in-the-money if the stock stays at its current price, but you have the right to sell it at a higher strike price.
It is important to note that a stock position can often be held for a very long period of time, all options eventually expire. As their expiration date approaches, options will generally lose value and can end up being worthless. Market volatility near expiration can also raise an investor’s risk of an option not being worth anything when it expires.
As a tip, choosing a call or a put option depends on what you want to achieve as an options trader. It is never a good idea to just pick an option for your portfolio without doing your research and deciding whether or not it aligns with your investing goals.
Why Options are so popular today
In crypto, for example, a number of crypto exchanges have noted rising trading volume after reaching lows earlier this year. Options strategies have featured prominently among institutional investors and even miners as they try to weather crypto’s usual volatility and a downturn that could last for months, or longer, despite recent hopeful macroeconomic signs.
More recently, traders have been using the crypto options market to bet on ether (ETH) and hedge positions as the Ethereum blockchain’s hotly anticipated Merge approaches. Panama-based derivatives platform Deribit, which is among the world’s largest exchanges for crypto options trading volume, stated in a report that Ether options trading is surging ahead of the Merge.
Because of the fact that Options can deliver very high returns and do so over a very short period of time, using the power of leverage to turn a relatively small sum of money into a huge sum, is the main reason why we are seeing this particular investment vehicle become very popular, despite the high level of volatility the Options market has as Options are generally risky, however, some options strategies can be relatively low risk and can even enhance your returns as a stock investor.
Should you trade Options?
As previously mentioned, Options trading is known to be quite risky, especially because of how complex it can be to understand. This is why it’s crucial that investors know how options work before getting involved. Investing your money in something you don’t understand is never a smart financial move.
The risk you take on as an options investor ultimately depends on your role in the contract (which side you’re on) and your strategy, as there are multiple strategies you can implement using different combinations of options. However, we ultimately advise that this type of asset has too much of a risk and small retail traders should not be trading this investment vehicle, without expecting to lose all their funds.
