Options trading is based on buying or selling underlying assets such as stocks, indices, commodities, etc. Options are derivative financial products that respond to a very particular operation, and which sometimes give possibilities of trading strategies that you cannot use with other instruments. Here’s how and why to trade options.
How to trade options?
Like stocks, listed options are traded on financial markets. It is essential to fulfill certain criteria in order to be able to buy or sell options directly on the stock exchanges. Thus, most retail savers use a broker. In this case, you trade the options with a traditional financial intermediary. You will trade on the platform of this one and, even more , will pay a commission, often invoiced with each order.
The broker will therefore execute orders on the markets on your behalf. Besides that, you can trade options through CFDs. The latter represent financial products that allow you to bet on the upward or downward variations of an underlying asset without ever owning it. To trade CFDs, you must open a trading account with an intermediary that offers derivatives.
Why trade options?
Options are fairly complex financial instruments. However, this does not prevent them from being popular with savers. This, because of the many advantages they offer:
Benefit from great leverage: trading options gives the possibility of seeking performance without necessarily tying up a lot of capital. So you can get an option position similar to a stock position while spending less money;
Trade with less risk: properly used, options reduce the risks associated with trading. In reality, they require less financial commitment than stocks. Moreover, the options present a relative imperviousness to the potentially catastrophic effects of opening gaps;
Access complex trading strategies: options remain a very flexible tool. Using them allows you, for example, to trade the third dimension of the market, i.e. trendless stock exchanges. In addition, they allow you to trade stock movements and volatility as well as the passage of time.
How to find the right option?
Whichever market you choose, once you identify the underlying asset to trade, there are six steps you need to take to find the right option:
Set your trading objective: this is the starting point for your investment;
Identify the risk/return ratio: determine this ratio taking into account your risk tolerance;
Check the implied volatility of options: compare the level of this volatility with the historical volatility of the stock and the level of volatility of the broader stock market;
Identify influential events: these can be classified into two categories: events relating to the market as a whole and those relating to specific stocks;
Define a strategy:
reviewing the previous four steps greatly facilitates the development of a specific option strategy;
Select the parameters of the option to trade: once your strategy has been identified, all that remains is to choose the parameters such as strike prices, expiry dates, etc.
Following these different steps will allow you to know when to exercise an option for the best results.