Buying Oats Call Options to Profit from a Rise in Oats Prices

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Call Option

What is a Call Option?

A call option, commonly referred to as a “call,” is a form of a derivatives contract that gives the call option buyer the right, but not the obligation, to buy a stock Stock What is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms “stock”, “shares”, and “equity” are used interchangeably. or other financial instrument Financial Assets Financial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity. A key at a specific price – the strike price of the option – within a specified time frame. The seller of the option is obligated to sell the security to the buyer if the latter decides to exercise their option to make a purchase. The buyer of the option can exercise the option at any time prior to a specified expiration date. The expiration date may be three months, six months, or even one year in the future. The seller receives the purchase price for the option, which is based on how close the option strike price is to the price of the underlying security at the time the option is purchased and on how long a period of time remains till the option’s expiration date. In other words, the price of the option is based on how likely, or unlikely, it is that the option buyer will have a chance to profitably exercise the option prior to expiration. Usually, options are sold in lots of 100 shares.

The buyer of a call option seeks to make a profit if and when the price of the underlying asset increases to a price higher than the option strike price. On the other hand, the seller of the call option hopes that the price of the asset will decline, or at least never rise as high as the option strike/exercise price before it expires, in which case the money received for selling the option will be pure profit. If the price of the underlying security does not increase beyond the strike price prior to expiration, then it will not be profitable for the option buyer to exercise the option, and the option will expire worthless, “out of the money”. The buyer will suffer a loss equal to the price paid for the call option. Alternatively, if the price of the underlying security rises above the option strike price, the buyer can profitably exercise the option.

For example, assume you bought an option on 100 shares of a stock, with an option strike price of $30. Before your option expires, the price of the stock rises from $28 to $40. Then you could exercise your right to buy 100 shares of the stock at $30, immediately giving you a $10 per share profit. Your net profit would be 100 shares, times $10 a share, minus whatever purchase price you paid for the option. In this example, if you had paid $200 for the call option, then your net profit would be $800 (100 shares x $10 per share – $200 = $800).

Buying call options enables investors to invest a small amount of capital to potentially profit from a price rise in the underlying security, or to hedge away from positional risks Risk and Return In investing, risk and return are highly correlated. Increased potential returns on investment usually go hand-in-hand with increased risk. Different types of risks include project-specific risk, industry-specific risk, competitive risk, international risk, and market risk. . Small investors use options to try to turn small amounts of money into big profits, while corporate and institutional investors use options to increase their marginal revenues Marginal Revenue Marginal Revenue is the revenue that is gained from the sale of an additional unit. It is the revenue that a company can generate for each additional unit sold; there is a marginal cost attached to it, which has to be accounted for. and hedge their stock portfolios.

How Do Call Options Work?

Since call options are derivative instruments, their prices are derived from the price of an underlying security, such as a stock. For example, if a buyer purchases the call option of ABC at a strike price of $100 and with an expiration date of December 31, they will have the right to buy 100 shares of the company any time before or on December 31. The buyer can also sell the options contract to another option buyer at any time before the expiration date, at the prevailing market price of the contract. If the price of the underlying security remains relatively unchanged or declines, then the value of the option will decline as it nears its expiration date.

Investors use call options for the following purposes:

1. Speculation

Call options allow their holders to potentially gain profits from a price rise in an underlying stock while paying only a fraction of the cost of buying actual stock shares. They are a leveraged investment that offers potentially unlimited profits and limited losses (the price paid for the option). Due to the high degree of leverage, call options are considered high-risk investments.

2. Hedging

Investment banks and other institutions use call options as hedging instruments. Just like insurance, hedging with an option opposite your position helps to limit the amount of losses on the underlying instrument should an unforeseen event occur. Call options can be bought and used to hedge short stock portfolios, or sold to hedge against a pullback in long stock portfolios.

Buying a Call Option

The buyer of a call option is referred to as a holder. The holder purchases a call option with the hope that the price will rise beyond the strike price and before the expiration date. The profit earned equals the sale proceeds, minus strike price, premium and any transactional fees associated with the sale. If the price does not increase beyond the strike price, the buyer will not exercise the option. The buyer will suffer a loss equal to the premium of the call option. For example, suppose ABC Company’s stock is selling at $40 and a call option contract with a strike price of $40 and an expiry of one month is priced at $2. The buyer is optimistic that the stock price will rise and pays $200 for one ABC call option with a strike price of $40. If the stock of ABC increases from $40 to $50, the buyer will receive a gross profit of $1000 and a net profit of $800.

Selling a Call Option

Call option sellers, also known as writers, sell call options with the hope that they become worthless at the expiry date. They make money by pocketing the premiums (price) paid to them. Their profit will be reduced, or may even result in a net loss, if the option buyer exercises their option profitably when the underlying security price rises above the option strike price. Call options are sold in the following two ways:

1. Covered Call Option

A call option is covered if the seller of the call option actually owns the underlying stock. Selling the call options on these underlying stocks results in additional income, and will offset any expected declines in the stock price. The option seller is “covered” against a loss since in the event that the option buyer exercises their option, the seller can provide the buyer with shares of the stock that he has already purchased at a price below the strike price of the option. The seller’s profit in owning the underlying stock will be limited to the stock’s rise to the option strike price but he will be protected against any actual loss.

2. Naked Call Option

A naked call option is when an option seller sells a call option without owning the underlying stock. Naked short selling of options is considered very risky since there is no limit to how high a stock’s price can go and the option seller is not “covered” against potential losses by owning the underlying stock. When a call option buyer exercises his right, the naked option seller is obligated to buy the stock at the current market price to provide the shares to the option holder. If the stock price exceeds the call option’s strike price, then the difference between the current market price and the strike price represents the loss to the seller. Most option sellers charge a high fee to compensate for any losses that may occur.

Call vs. Put Option

A call and put option are the opposite of each other. A call option is the right to buy an underlying stock at a predetermined price up until a specified expiration date. On the contrary, a put option is the right to sell the underlying stock at a predetermined price until a fixed expiry date. While a call option buyer has the right (but not obligation) to buy shares at the strike price before or on the expiry date, a put option buyer has the right to sell shares at the strike price.

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How To Lose Money Buying Call Options In A Rising Market

Options strategies are not obvious.

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Option trading and stock trading is different on many levels.

Stock traders gain when the stock goes up, and lose when it goes down. It’s that simple. Option premium buyers not only need to pick the right direction of the stock, but the stock’s move must happen in a certain amount of time (before the option expires).

Furthermore, there is a premium built into options — the implied volatility (IV) — which tells us how much other option traders expect that stock to move. Therefore, not only do these speculators need the underlying to move in the right direction and within a certain time frame, but also by more than other option players are predicting.

So, the implied volatility of an option reflects the market’s expectations for the underlying stock’s price movement. Large-cap stocks that have been around a long time tend to move less than small-cap stocks, and therefore tend to have lower implied volatilities. The lower the implied volatility, the less the stock has to move for the option to make a profit.

Premium buyers have a trade-off to consider when deciding which companies’ options to buy. They can buy low-priced options on stocks that do not tend to make big, quick moves (but that don’t have to make a big move for the option to profit), or they can buy higher-priced options on stocks that have more potential to make a big move. So, looking back at 2020, I decided to see which strategy would have paid off best.

Last year, the big caps led the way. The Dow Jones Industrial Average (DJIA) was up 5.5%, while the Russell 2000 Index (RUT) lost about 5.5%. The S&P 500 Index (SPX), meanwhile, was pretty much flat. You could substitute the ETFs: DIA, IWM and SPY, respectively.

Since the Dow is composed of 30 large-cap companies that tend to have low implied volatilities, I assumed it would have been most profitable to buy options on these stocks. Good thing I checked the numbers, because it didn’t turn out exactly as I’d expected.

Premium Buying in 2020: When I focus on option price comparisons for certain subsets of stocks, rather than comparing whether the stocks went up or down, I do so by comparing the returns on long straddles on the stocks.

Straddles are implemented by purchasing both a call and a put at the same strike, with the intention of making a profit whether the stock goes up or down. The stock does, however, have to make a pretty decent-sized move to make up for the fact that you’re buying double premium. In other words, the direction of the stock doesn’t matter — only the size of the move and the prices of the options.

For this study, I assumed that on each monthly expiration date in 2020, you purchased an at-the-money straddle on each stock which expired on the following expiration date (one month later). Then, I broke the stocks down into three equal groups, depending on their implied volatilities. The table below summarizes their returns. The low-IV stocks did have the worst performance of the bunch. Purchasing a straddle on these stocks each expiration would have netted you a loss of almost 1.23%. By contrast, buying straddles on the expensive options would have generated a gain of 1.81%.

Call Options vs. Put Options: For each of those subsets of stocks, I then looked at how it would have turned out if you had purchased a slightly in-the-money call option or a slightly in-the-money put option. Looking at the table below, you’ll notice the call options had negative returns across all brackets. The low IV bracket had the least negative returns, at -5.4% — which is not surprising, considering the Dow outperformed the small-cap RUT.

The big profits last year would have been made by buying put options on the high IV stocks. A trader doing that would have gained an average of 13.5% on each trade.

So, though the Dow was up 5.5% last year, the stocks with low implied volatility would have still lost money had you purchased call options all year. However, the high IV stocks would have returned solid profits, had you bought puts all year. Surely, the majority of those profits would have come in the third quarter, when the SPX fell about 18% from late July to early August.

We’re an investment research company specializing in options trading, strategies, and education. We’re also big fans of sentiment analysis, with a contrarian edge.

We’re an investment research company specializing in options trading, strategies, and education. We’re also big fans of sentiment analysis, with a contrarian edge.

Short selling versus put options: a guide for investors

Short selling and buying put options can be used to profit from falling share prices. But what differentiates the two approaches and how do they stack up against each other?

Put options

With options, we pay a non-refundable sum of money, known as a contract premium, to gain the chance to profit from a move in an underlying security price.

Buying a call option allows us to profit from upward moves in shares, whereas buying a put option enables us to profit from down moves.

Buying a put option, otherwise known as taking a ‘long-put’ position, provides us with the opportunity to theoretically sell an underlying share at a predetermined price and by a certain date.

In practice, when an option contract position has gone our way, we should be able to simply close the position with one click on our laptop to realise profits.

When we purchase a put option, our maximum loss is always limited to the contract premium.

Profiting from puts

For example, suppose the shares of DriverlessCar Company are trading at $160, as at 1 May. A put option contract with a strike price of $150 expiring in a month from now is priced at $3.

We expect the stock price to fall over the coming weeks; we pay $3,000 to acquire put options covering 1000 shares.

Fortunately for us, at option expiry the share price has fallen to $140. Our put options are now ‘in the money’ with a total intrinsic value of $10,000 and we can now sell them for that amount.

In this simplistic example, the intrinsic value of our put options is equal to the difference between the strike price and the option price at expiry multiplied by the number of shares being covered by the contracts.

As we paid $3,000 to buy the put options, our profit from the position is $7,000:

Profit= $10,000 intrinsic value – $3,000 contract premium = $7,000

Limited risk

While put options can offer attractive returns, the downside is limited. Suppose the share price of DriverlessCar remains in a fairly narrow range before rising sharply at contract expiry to $185 after the company reports strong results from new product launches.

In this case, the put option was unprofitable, or in other words remaining ‘out of the money’.

On the bright side, even though the shares rose sharply before our option contracts expired, our loss is still limited to the $3,000 in premiums we paid at initiation on 1 May. The profit potential on a long put is also limited as a share cannot fall below zero.

While long puts can be used for speculative reasons, they are well suited for hedging the risk of a decline in the conventional portfolios and shares that we hold.

Consider the situation of a fund manager who is compelled by their mandate to always hold a certain percentage of a portfolio in equites during all market conditions, including bear markets.

Gains from long-put positions can be a welcome relief, offsetting at least some of the losses from conventional shareholdings.

At other times, rises in the value of our traditional holdings can easily counterbalance the contract premiums paid for our put options.

Low probability

It may all sound too good to be true, but the probability of an option contract being ‘in the money’ and providing us with a profit in its own right is typically only 25%.

The probability is a function of the volatility of the option and the length of the contract; the higher both these factors are, the more likely it is that the strike price on the long-put contract will be reached.

When it comes to options, volatility could be thought of as our friend – higher share price volatility increases our chances of making a profit. In a low volatility situation, when an underlying share price remains virtually unchanged, we´ve still lost the option premium that we paid at the initiation of the contract.

However, the cost of contracts on stocks with higher volatility will also be greater, reducing our potential for profit.

Buying contracts on stocks with lower volatility, but which we believe hold strong potential for share price movement due to events, can prove to be better value.

Some stocks are a lot more volatile than others, with ‘beta’ commonly used as a measure of share price volatility.

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For instance, a share with a beta of 0.9 could be thought of as being 10% less volatile than the market average. A share with a beta of 1.2 is theoretically 20% more volatile than the market.

Short selling

Like long puts, short selling enables us to profit from downward movements in share prices. As with puts, the potential gains are limited because a share price cannot fall below zero.

However, unlike using puts, the potential losses from short selling are theoretically unlimited.

To initiate a short-selling trade, we must borrow shares and then sell them in the market. If the share price drops as we hope, we can then buy them back at a lower price.

This price difference forms the basis of our profit from the trade. However, if the share price rises sharply, we are fully exposed to the resulting losses.

If the price does rise significantly, we could be compelled to provide additional margin (the money a broker requires as security for a trade) in addition to the initial margin we would have had to post at the outset of the trade.

Margin of error

One advantage of put options is that there is no such margin (borrowing) requirement involved. Typically, 50% of the total sale amount must be posted as margin at initiation of a short-selling trade.

This equates to $80,000 if we had sold short 1,000 shares in DriverlessCar Company when the share price was at $160 on 1 May.

If the share price had fallen to $140 as in the earlier example, our potential profit from short selling would have been:

($160 – $140) x 1,000 = $20,000

If the shares had subsequently risen to $185, our paper loss from short selling would have been:

($185 – $160) x 1,000 = $25,000

In this scenario, the put option contracts appear much more favourable as our losses were limited to $3,000.

Short selling entails less risk when the security being shorted is a market index or an exchange-traded fund (ETF). This is because individual shares carry much more potential for sharper movements.

Regulations have been imposed in recent years to make short selling more transparent. Some of the larger short-sale positions of financial institutions can be viewed on regulators´ websites.

*excludes cost of borrowing stock short or any interest payable on margin account.

Time advantage

On the flip side, short selling offers the advantage of time. Unlike with a put, there is no time limit on the trade, provided of course that we can keep funding any additional margin requirements that may be due to the broker.

While the holder of a put option´s losses are strictly limited to the contract premiums they pay at initiation, an option is highly likely to expire out of the money.

In contrast, the short seller could choose to wait it out if they believe the share price will fall in the long term. While being significantly more expensive than long puts, and with much higher potential losses, the short seller gets the advantage of time.

Short selling or long puts?

Both short selling or long puts can be used either to speculate or as a means to hedge risk.

Due to the risks involved, short selling should only be contemplated by sophisticated investors with deep pockets.

As the risk of loss from a long-put contract is limited to just the premiums paid at initiation, put options are likely to be much more suitable for the average investor.

To learn how short selling can work for your trading strategy watch our video:

Short selling versus put options: a guide for investors

Short selling and buying put options can be used to profit from falling share prices. But what differentiates the two approaches and how do they stack up against each other?

Put options

With options, we pay a non-refundable sum of money, known as a contract premium, to gain the chance to profit from a move in an underlying security price.

Buying a call option allows us to profit from upward moves in shares, whereas buying a put option enables us to profit from down moves.

Buying a put option, otherwise known as taking a ‘long-put’ position, provides us with the opportunity to theoretically sell an underlying share at a predetermined price and by a certain date.

In practice, when an option contract position has gone our way, we should be able to simply close the position with one click on our laptop to realise profits.

When we purchase a put option, our maximum loss is always limited to the contract premium.

Profiting from puts

For example, suppose the shares of DriverlessCar Company are trading at $160, as at 1 May. A put option contract with a strike price of $150 expiring in a month from now is priced at $3.

We expect the stock price to fall over the coming weeks; we pay $3,000 to acquire put options covering 1000 shares.

Fortunately for us, at option expiry the share price has fallen to $140. Our put options are now ‘in the money’ with a total intrinsic value of $10,000 and we can now sell them for that amount.

In this simplistic example, the intrinsic value of our put options is equal to the difference between the strike price and the option price at expiry multiplied by the number of shares being covered by the contracts.

As we paid $3,000 to buy the put options, our profit from the position is $7,000:

Profit= $10,000 intrinsic value – $3,000 contract premium = $7,000

Limited risk

While put options can offer attractive returns, the downside is limited. Suppose the share price of DriverlessCar remains in a fairly narrow range before rising sharply at contract expiry to $185 after the company reports strong results from new product launches.

In this case, the put option was unprofitable, or in other words remaining ‘out of the money’.

On the bright side, even though the shares rose sharply before our option contracts expired, our loss is still limited to the $3,000 in premiums we paid at initiation on 1 May. The profit potential on a long put is also limited as a share cannot fall below zero.

While long puts can be used for speculative reasons, they are well suited for hedging the risk of a decline in the conventional portfolios and shares that we hold.

Consider the situation of a fund manager who is compelled by their mandate to always hold a certain percentage of a portfolio in equites during all market conditions, including bear markets.

Gains from long-put positions can be a welcome relief, offsetting at least some of the losses from conventional shareholdings.

At other times, rises in the value of our traditional holdings can easily counterbalance the contract premiums paid for our put options.

Low probability

It may all sound too good to be true, but the probability of an option contract being ‘in the money’ and providing us with a profit in its own right is typically only 25%.

The probability is a function of the volatility of the option and the length of the contract; the higher both these factors are, the more likely it is that the strike price on the long-put contract will be reached.

When it comes to options, volatility could be thought of as our friend – higher share price volatility increases our chances of making a profit. In a low volatility situation, when an underlying share price remains virtually unchanged, we´ve still lost the option premium that we paid at the initiation of the contract.

However, the cost of contracts on stocks with higher volatility will also be greater, reducing our potential for profit.

Buying contracts on stocks with lower volatility, but which we believe hold strong potential for share price movement due to events, can prove to be better value.

Some stocks are a lot more volatile than others, with ‘beta’ commonly used as a measure of share price volatility.

Historic oil price drop
Don’t miss your trading opportunities

For instance, a share with a beta of 0.9 could be thought of as being 10% less volatile than the market average. A share with a beta of 1.2 is theoretically 20% more volatile than the market.

Short selling

Like long puts, short selling enables us to profit from downward movements in share prices. As with puts, the potential gains are limited because a share price cannot fall below zero.

However, unlike using puts, the potential losses from short selling are theoretically unlimited.

To initiate a short-selling trade, we must borrow shares and then sell them in the market. If the share price drops as we hope, we can then buy them back at a lower price.

This price difference forms the basis of our profit from the trade. However, if the share price rises sharply, we are fully exposed to the resulting losses.

If the price does rise significantly, we could be compelled to provide additional margin (the money a broker requires as security for a trade) in addition to the initial margin we would have had to post at the outset of the trade.

Margin of error

One advantage of put options is that there is no such margin (borrowing) requirement involved. Typically, 50% of the total sale amount must be posted as margin at initiation of a short-selling trade.

This equates to $80,000 if we had sold short 1,000 shares in DriverlessCar Company when the share price was at $160 on 1 May.

If the share price had fallen to $140 as in the earlier example, our potential profit from short selling would have been:

($160 – $140) x 1,000 = $20,000

If the shares had subsequently risen to $185, our paper loss from short selling would have been:

($185 – $160) x 1,000 = $25,000

In this scenario, the put option contracts appear much more favourable as our losses were limited to $3,000.

Short selling entails less risk when the security being shorted is a market index or an exchange-traded fund (ETF). This is because individual shares carry much more potential for sharper movements.

Regulations have been imposed in recent years to make short selling more transparent. Some of the larger short-sale positions of financial institutions can be viewed on regulators´ websites.

*excludes cost of borrowing stock short or any interest payable on margin account.

Time advantage

On the flip side, short selling offers the advantage of time. Unlike with a put, there is no time limit on the trade, provided of course that we can keep funding any additional margin requirements that may be due to the broker.

While the holder of a put option´s losses are strictly limited to the contract premiums they pay at initiation, an option is highly likely to expire out of the money.

In contrast, the short seller could choose to wait it out if they believe the share price will fall in the long term. While being significantly more expensive than long puts, and with much higher potential losses, the short seller gets the advantage of time.

Short selling or long puts?

Both short selling or long puts can be used either to speculate or as a means to hedge risk.

Due to the risks involved, short selling should only be contemplated by sophisticated investors with deep pockets.

As the risk of loss from a long-put contract is limited to just the premiums paid at initiation, put options are likely to be much more suitable for the average investor.

To learn how short selling can work for your trading strategy watch our video:

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    The Best Binary Options Broker 2020!
    Perfect For Beginners and Middle-Leveled Traders!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Broker For Experienced Traders!

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