The world of options is engaging more and more investors by the day. As traders of all kinds learn about the profit available through the option market, it is experiencing growth and broadening the industry. You may have heard of options before, but the truth is that most citizens, including some very savvy investors, really don’t know or understand how they work. Therefore, before explaining “Exchange Traded Options”, let’s make sure you understand what an option is.
Options function by pairing a buyer and seller and offering a system for controlling an underlying asset. Consider, for example, a call option. It allows the buyer of the option the legal right, but not the obligation, to purchase the underlying asset at any time, for a particular, pre-determined strike price, before a particular, pre-determined expiration date. This gives the buyer the right to make a decision and ultimately, the decision to “exercise the option,” or buy the asset, is one that can lead to financial gain or loss.
Indeed, options trading can be opportunistic. For traders capable of accurately predicting the fluctuations of a constantly changing stock market, options can actually be quite lucrative. The reasons options are difficult, though, stems from how insanely challenging it is properly foresee the ups and downs of the market. But regardless, for sophisticated traders and novice ones with high aspirations, options are appealing financial instruments that accomplish several important objectives.
For one, they help investors minimize risk and hedge investments. They also help traders diversify their portfolio by adding more than simple securities to the mix. If used correctly, options can provide the otherwise impossible pleasure of controlling large assets with comparatively low capital. That may help to explain its across-the-board popularity despite its somewhat complex nature as a derivative instrument.
But it’s crucial also to distinguish between over the counter options and exchange traded options. While the former are sort of casual transactions between two private parties, the latter is far more standardized. Traders familiar with stocks and mutual funds may equate OTC options with mutual funds purchased directly from a company while likening exchange traded options to stocks, like Google, Apple, or Yahoo, purchased and sold on the NYSE.
While traders make use of both types of options, many are more comfortable with exchange traded options because they are exchanged on a market with rules, regulations, standards, and a sense of stability. OTC options may make some uncomfortable and promote less accountability, but some are drawn to it for their own reasons. The fact is, though, that exchange traded options have guarantees and standardization, features many traders are attracted to.
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