skip to Main Content
Get your free daily newsletter: Actionable insight every morning for the self-directed investor. 
Join

My real passion is trading futures…well my real passion is trading However, there have been times such as since C-19 when the markets became too highly volatile to use futures.

To want to use options you must have a longer-term view of where you expect the market to be heading. I always advise guys coming through my courses – when we get to options – to buy options, as this way you limit any potential loss from day one. Another advantage of buying options is you do not have to micromanage the risk.


Although it is best to buy options it does not mean you have to be long the market. There are two main options types: call options, as a buyer of the option you expect the market to trend higher, and put options, as the buyer you expect the market to trend lower.

An option provides the buyer the right but not the obligation to accept the position. Options are valued off the underlying contract which if using the traditional exchanges is the futures contract.

The key elements of options trading

  • Strike price: the market price used as the basis of the option contract
  • Premium: The cost to the buyer for limiting his loss
  • Volatility plays a major role in the premium of an option along with duration. Higher volatility will increase the premium as will a longer duration.
  • Options are available in duration from hours to months.
  • Traders that trade options as a business are fixated on the ‘Greeks’, gamma, delta, vega and theta, as they use these to provide the intrinsic value of options.
  • At expiry, the option will be abandoned if the strike price is against the buyer or exercised if the strike price is favourable.

Options strategies: straddles and strangles

There are many strategies that can be generated by trading options. The two I favour most are straddles and strangles. These are useful at times of high volatility, especially if you feel the market is due for a big move but uncertain of the direction! They both include call and put options, which provides you with a long and short position in the same contract with the same expiry. The key difference is a straddle will use the closest strike price for both (At-The-Money) whereas the strangle will use strike prices further away from the current market (Out-of-The-Money), which is favourable for the seller, as although he receives less premium, the market has to move further before the buyer will be in profit…or In-The-Money. The buyer of the strangle will do this to reduce the cost of the premium.

As the buyer of the option the maximum you can lose is your premium. I always describe this as like taking out an insurance policy, it’s just in case! With options, it’s just in case your view is wrong!

Once I am in the money (ITM) options become interesting. I like to use the futures to hedge my options positions.

A worked example:

  1. Gold currently trading $1903.2
  2. Strike price (ATM) $1900.0 as nearest.
  3. Buy a December call option for $1.4 premium, this would be $1,400 in real money as $10 per tick (pip).
  4. My break-even level is $1901.4 calculated as $1900.0 plus the premium of $1.4 Anything above $1901.4 is a potential profit.
  5. When I consider the market is preparing to turn, I hedge my option position by selling the futures contract.
  6. Each time the market drops I buy the futures back and each time it rallies I sell again. It is possible to make substantially more from the futures hedging than the premium paid out!

Options are useful; however, the key is you must be right and ITM at least once before expiry to benefit from them.

Selling options has unlimited risk and requires constant monitoring to manage the risk. Trending markets or static markets are preferred to ranging ones, although it depends on the strike price!

Armchair Trader readers can currently enjoy a discount on Chris Tubby’s trading courses using the discount code ARMCHAIR5% when booking. More details on Chris’ courses can be found at www.masterc.co.uk 

Related

Become a better investor with SharePad Designed to give you the confidence to pick your own investments, Sharepad gives you access to a wealth of information on UK, US & European stocks. Find out more

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Chris Tubby

Chris Tubby

Chris Tubby started his career in commodities, becoming a senior trader by the age of 22. He moved on to the financial markets when they came to London in the early 80s. Chris has traded, prop, arbitrage and as a market-maker for various exchanges on a range of products - STIRs, Equity index for an Italian Bank in Milan, energy for both the major Oil exchanges, Gold, HRC, MSCI, Iron ore, Cocoa, and Wheat.

Chris enjoys passing on his knowledge, passion and trading skills to others and watch them mature into traders through his range of courses.

Armchair Trader readers can receive a 5% discount on Chris's range of trading courses using the discount code ARMCHAIR5%

Stocks in Focus

Here are some of the smaller companies we are following most closely. They all represent significant growth stories in our view. Our in-depth reports go into more detail on why we like them.

Comments


Get your free daily newsletter: Actionable insight every morning for the self-directed investor. 
Join

Thanks to our Partners

Our partners are established, regulated businesses and we are grateful for their support.

Pepperstone
FP Markets
IG
Spreadex
Trade Nation
WisdomTree
ActivTrades
Back To Top