Glancing through the financial newspapers, magazines and other publications related to investing and trading, you noticed large advertisements of success stories of people becoming millionaires by trading options. You start to ponder for a few seconds and think whether is it for real? The term “option” seems so foreign to you but yet it seems so familiar at the same time.
You know you have heard of this term before but you just could not recall where as you are too preoccupied with the things you were doing. One thing to be certain is, advertisements mentioning these type of financial instruments are definitely becoming more and more common in the financial publications that you have been reading. You know you definitely have to find out more. By the way, who doesn’t like to have more options when it comes to decision making on what to invest in when its about the diversification of your own portfolio?
Welcome to the world of derivatives. Options is just one type of derivative. The term “derivative” means that each kind of financial instruments classified under its category, do not have intrinsic value of their own. They derive their value from the underlying assets. There are many kinds of derivatives such as forwards, futures, warrants, swaps…etc The main focus here will be options.
Options are simply contracts that grant the holder the rights and not the obligation to buy or sell an asset at a pre-agreed fixed price, also known as the strike price, before the date of expiration. There are many types of options, they are: stock options, future options, foreign currency options, interest rate options, and index options. If you are a active trader in the market, you may view these contracts as insurance for stock holders in the event the market start to turn against their positions.
These contracts work wonders as a hedging tool and yet it is also tradeable as a separate instrument. You may even decide to make the decision to own the underlying asset if ownership is what you look for when the pricing of the asset is at a real bargain. When you compare trading options to trading stocks, stocks pale in comparison as options offer 6 different ways to earn money while stocks only provides you 2 ways of earning money. The number of strategies options provide, will definitely shock you as it is also a hedging tool by itself.
So what’s the main reason that options are becoming more and more popular? The answer boils down to one word, that is leverage. With a small amount of capital, you can actually start to make money by trading options itself. This has allowed more and more people to jump into the hot soup to make money with only a small initial capital outlay. People from all walks of life are able to trade options that are tied to very expensive underlying assets since the price of the contracts are much cheaper than the asset itself. With an increasing number of people trading options, this has definitely created a vibrant options market over the years.