Concept of Options Trading

Concept of Options Trading

Submitted by adil on Sun, 12/04/2011 - 02:12

Options are contracts that give the buyer the right, but not the obligation, to buy or sell an asset at a set price by a fixed date. Meanwhile the seller of the option is obliged to sell or buy the asset in the contract if the buyer decides to carry out the options contract. It is very simple to understand the idea of options trading.

Here is an example to understand options trading. Suppose you want to buy an asset convertible for sale for $100,000. Let�s say you don�t have enough capital at the moment to pay all the money. Then you contact the current owner and the two of you write a contract that enables you to buy the convertible in a fixed number of days (suppose 30 days) for $100,000. For exclusive rights to this contract, you deposit $1,000 to the current owner of the asset.

The price of the car is expected to remain static for the next thirty days. However, there is the possibility that its value will change or fall. So there are three possibilities that can happen in next 30 days.

Condition One:

Suppose the value of the asset increases in that period of time. You can sell the asset at new market price and earn the profit. In the contract you have signed a fixed $ 100,000 to pay. So you will pay only that amount to the owner. No matter how high the new prices are in the market.

Condition Two:

Suppose the price of the asset remains same at the end of expiry of days. You have the option to buy the asset by paying rest of the money or you can leave the asset as it is to the owner. In that case you will lose the premium that you have paid for the original contract.

Condition Three:

Now let�s suppose the market price of the asset drops down and you are in a condition of loss to buy the asset. In this situation, you can still decide to not to buy the asset and lose only the premium.

Options are available across a wide range of markets, including the stock, commodity, bond, interestrate and Forex markets. You can decide which one suits you. Intellitraders is a free  trading online community to help traders in learning and making money through their trading platform.