Intro to Options

Welcome to the first lesson of “An Introduction to Options”. This is the first of four sessions which will be delivered over to help you determine if options have a place in your Investment Trading program.

ABOUT THE AUTHORS: This course is being brought to you as a service of dynamic trader.com. The lessons were compiled by me Daniel Mankani, in the nineties as part of an educational investment program, while I was  a licensed futures broker at Phillip GNI Futures Pte Ltd (Singapore) all information here is not necessary that of Phillip GNI but of Daniel-dynamictrader.com. Daniel as a market advisor worked one on one with customers who use the futures and options for hedging and speculative purposes specializes in assisting traders with their trading plans by using the dynamic trader -trend trading dynamics concept, he also provides market commentary and recommendations over the internet and as well as through several print publications.

The material contained herein and the entire options and futures courses have be obtained from sources deemed to be reilable, credits are given to Roy Paterson, Scott Stewart, Bryan Doherty, of the Stewart-Paterson Advisory Group for their outstanding effort in developing this options course.

PURPOSE: The  Options course Seminar was conceived as a way to help Investors become more at ease with the use of options and, consider options trading in their Investment Trading Plans  which is allowed for real-time application and examples. With the technology of internet, these objectives can now be realized. This program will not only introduce you to the terminology and and provide explanations of options, but also real-life problems and examples based on prices right now.

Throughout the program, we will be referring to both sessions and lessons. When the word session is used , its referred to a block 12 of lessons. This is  currently in session 1, the Intro to Options. Future sessions will become progressively more advanced. Session 2 will cover: understanding premium and volatility, selecting a strike price, figuring a breakeven and understanding profit and loss. Session 3 deals with: combination positions, vertical spreads, fences and covered writes. Session 4 covers: hedge ratios (delta), exotic spreads and trading for a profit.

In session 1, an Intro to Options, we’ll be covering the following topics: history of options, options as insurance, defining puts and calls, defining premium, defining strike price, offsetting expired and exercising options, figuring a breakeven, selling strategies, and buying strategies.

OPTIONS AS PART OF A TOTAL INVESTMENT TRADING PROGRAM

As we begin our study of options, we will start by talking about a “total investment trading program”. we will also start by saying that options will not be the answer to every traders investment  dilemma, in fact, they add a new dimension to your decision-making process. But any new idea takes time to learn. It takes more knowledge to understand how to operate a new combine than it does some of the older models, but yet few people are trading their new tool for trading futures built back in the ’60s. And, just as not everyone uses the exact same combine, not every trader   will find it necessary or even appropriate to use options in the same manner. What’s important, however, is that we take the time to evaluate their application for each investment operation in futures.

A total investment trading program is like a tool box that contains many types of tools. These tools include cash trading(i.e cash stock, currencies), forward contracting, futures, options and combinations of all the above. And just as no one tool out in the shop can do every job, the same is true of your investment tools. At one time cash trading may have been the only choice, but that is no longer true. You now have many choices. Its our strong recommendation that as you consider your overall marketing, that you implement an aggressive program of diversification. Many traders have learned over the years that there is a lot of merit in not putting all your eggs in one basket. Some diversification has been found to be good and to provide a stabilizing effect on many farms. Investment Trading is very similar.

An often stated goal by many traders is to sell in the upper third of the annual price range. Diversifying your trading can help move you a step closer to that goal.  it’s important, as you lay out your investment plan, that you incorporate the use of cash trading along with the use of forward contracting, some futures and some options. This mix of activities will vary from trader to trader. Some traders, depending on their experience and financial condition, will tend to be biased toward one or the other more heavily.

Your ability to manage and deal with risk will also determine how heavily you rely on one form of market or another. Because of some investors financial situation and credit availability, the use of futures and options may be totally inappropriate, while for others options may be required. Some traders may be willing to forego some of the fixed risk characteristics of an option position for the larger profit opportunity that a futures contract may offer.

As we talk about selecting a marketing method, an important theme is also starting to surface, the idea of risk management. The purpose of this program is to help you understand not only options, but how they help you with risk management. The basic idea upon which the markets were established was to provide a way to transfer risk from the producer to a speculator. Much of this course will be written in that light.

BACKGROUND AND HISTORY

Many people have the idea that the futures markets are a relatively new phenomena in our culture. Most people are surprised to learn that futures contracts actually began trading in the mid 1800s. Many people also believe that options are a relatively new development. That is just not the case. Options have been traded on stocks for many years and were even traded on agricultural products some 50 years ago. For a variety of reasons, however, they were discontinued but reintroduced during the 1980s. Since that time, popularity and interest has grown substantially.

Options are contracts directly linked to the futures market. In some other markets options give you the right to buy or sell the physical product. In the case of real estate if you have an option on a piece of land and use that option, you actually end up with land and not simply a futures contract for land. If you have an option for stock, you actually end up with stock and not simply a futures contract on stock. With options on futures, however, they are based on a futures contract and not on the actual cash product. For example, a Stock Index option does not result in you receiving or delivering stocks but rather a stock index futures contract.

BUT WHAT ACTUALLY IS AN OPTION? An option (from the perspective of the buyer) gives you the right to buy or sell a particular futures contract at a specific price within a certain period of time. An option is a legally binding contract which is traded on one of the commodity exchanges.

So who uses options? Options are used by many people. We should first divide the market participants into the broad categories of hedgers and speculators. A hedger as someone who is seeking to transfer risk from themselves to a risk taker.

So who are the speculators? A speculator by our definition is someone willing to take on risk with the objective of earning a profit. This would normally be someone who has determined that taking on such risk is suitable for them considering their financial situation;