Vanilla options are useful tools to add to your trading toolbox. They help you in different ways. First of all, they can help you manage risk and protect your downside. Second, they can help you take advantage of potential market opportunities. In essence, options contracts enable you to reduce future uncertainty of price fluctuations, by giving you the right, but not the obligation, to buy or sell a specific asset within a specific timeframe at a specific price. Usually, traders and investors only exercise that right when the benefits are greater than the costs.
There are several trading tips for vanilla options. Below we will explain key steps that help you trade options better. There are plenty of strategies you can implement but the basic steps remain the same.
Here we’ll look at the main steps to trading options and how to take advantage of potential opportunities.
- Choose an options platform. You need to choose an options platform that is reliable and reputable (one example is this) to ensure safety and security.
- Analyze the spot market and make a prediction. Let us assume you are looking at the West Texas Intermediate (WTI) crude oil market. The price is $50 per barrel. You expect the price to rise to $80 per barrel and you are confident in your prediction. Next:
- Time your prediction. In addition to the price forecast, you will also need to time your prediction. Let us assume you expect the price to rise up to $80 within 5 months. This usually makes it more challenging as you need to be more accurate.
- Check the price of options contracts, both put options, and call options. Call options on WTI enable you to buy the oil at a determined price in the future. Put options on oil to enable you to sell it in the future.
- Check the strike price of the option, which is the price at which you can buy or sell the oil in the future.
- Search for call options on oil at an exercise price that is much less than $80 and which lasts for 5 months. Let us assume you could find a call option that costs $5 and offers you to buy oil at $60 within 5 months. This makes the total cost $65 per barrel. If your prediction turns out to be true and the price of oil soars to $80, then you can exercise the right and buy oil at $60 and then sell it right away at $80. With the total cost being $65 per barrel, your profit will be $15 per barrel. If you bought 1000 barrels your profit will be 15,000. If, on the other hand, you expect the price of oil to drop, let us say to $20, then you should search for put options where you can sell oil at $40 within five months. If your prediction is correct, you will be able to sell oil at $40 per barrel and then buy it at $20. Your gross profit will be $20 per barrel and your net profit will be $15 assuming the cost of the option is $5.
- If your prediction is incorrect, you only lost the cost of the option which is around $5 as we assumed.
The above is a simplification of the process of trading from home with vanilla options. You can devise more creative strategies based on that, but the underlying principles remain the same. Make sure you manage your risk carefully before starting trading or investing.
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