Listed options are a type of financial derivative that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price within a specific time frame. The most common underlying assets are stocks, exchange-traded funds (ETFs), and futures contracts.
Options are listed on exchanges and can be traded through brokerages, and they are regulated by the Securities and Exchange Commission (SEC). Traders use options to speculate on the future direction of an underlying asset or to hedge against risk in their portfolios.
Types of listed options
Call options give the holder the right to buy an underlying asset at a specified price within a specific time frame. Traders use call options to speculate on rising prices or hedge against risk in their portfolios.
Put options give the holder the right to sell an underlying asset at a specified price within a specific time frame. Traders use put options to speculate on falling prices.
You can exercise American-style options at any time before expiration. You can use American-style options when you think the underlying asset price will move very quickly or when you want the flexibility to exercise your option at any time.
You can only exercise European-style options on the expiration date. You might use European-style options when you think the underlying asset price will move slowly or don’t want the flexibility to exercise your option before expiration.
Exotic options are complex financial instruments with unique features not found in standard options contracts. These features include non-standard expiration dates, underlying assets, and strike prices. Exotic options are often used by hedge funds and other sophisticated investors to speculate on the future direction of an underlying asset.
Risks listed in options trading
Volatility measures how much an asset’s price increases over time. Options are more sensitive to changes in volatility than the underlying asset, meaning options prices can fluctuate more dramatically than the underlying asset.
Liquidity measures how easy it is to buy and sell an asset without affecting its price. Options are typically less liquid than the underlying asset, and it may be challenging to find buyers or sellers, and options prices can be more volatile.
Rewards associated with listed options
Leverage is the ability to control a large amount of an asset with a small investment, says Investopedia. Options offer leverage because you only have to pay a fraction of the underlying asset’s price.
Options contracts have predetermined expiration dates and strike prices, and your potential loss is limited to the premium you paid for the option.
How to trade listed options
Choose an underlying asset
The first step in trading options is to choose an underlying asset, which can be a stock, index, currency, or commodity.
Select an options expiration date
The expiration date is the date when the option contract expires. Options can have short-term expiration dates of one week or minor or long-term expiration dates of one year or more.
Choose a strike price
The strike price is the price at which the holder can buy or sell the underlying asset. For call options, this is the price at which you can buy the asset. For put options, this is the price you can sell the asset.
Determine whether to buy or sell
If you think the underlying asset will increase in value, you will buy a call option. If you think the underlying asset will decrease in value, you will buy a put option.
Place your trade
Options trades are typically placed through an online broker. You will need to provide your broker with options specifications, including the underlying asset, expiration date, strike price, and whether you are buying or selling.
Monitor your trade
Once your trade is placed, you will need to monitor it until expiration. It means keeping an eye on the underlying asset’s price and tracking the time decay of your options contract.
Close your trade
If you are in a profitable position, you can close your trade at any time by selling your options contract. If you are in a losing position, you can let your options contract expire worthlessly.
Read this article for more information about listed options.