Types of options trading strategies
Options contracts come with an expiration date, at which point the owner has the right to buy the underlying security if a call or sell it if a put. With American style options, the owner of the contract also has the right to exercise at any time prior to the expiration date. This additional flexibility is an obvious advantage to the owner of an American style contract.
You can find more information, and working examples, on the following page — American Style Options. The owners of European style options contracts are not afforded the same flexibility as with American style contracts.
If you own a European style contract then you have the right to buy or sell the underlying asset on which the contract is based only on the expiration date and not before.
Please read the following page for more detail on this style — European Style Options. Also known as listed options, this is the most common form of options. They can be bought and sold by anyone by using the services of a suitable broker. They tend to be customized contracts with more complicated terms than most Exchange Traded contracts.
When people use the term options they are generally referring to stock options, where the underlying asset is shares in a publically listed company.
While these are certainly very common, there are also a number of other types where the underlying security is something else. We have listed the most common of these below with a brief description. The underlying asset for these contracts is shares in a specific publically listed company. Contracts of this type grant the owner the right to buy or sell a specific currency at an agreed exchange rate. The underlying security for this type is a specified futures contract.
A futures option essentially gives the owner the right to enter into that specified futures contract. The underlying asset for a contract of this type can be either a physical commodity or a commodity futures contract.
A basket contract is based on the underlying asset of a group of securities which could be made up stocks, currencies, commodities or other financial instruments. Contracts can be classified by their expiration cycle, which relates to the point to which the owner must exercise their right to buy or sell the relevant asset under the terms of the contract.
Some contracts are only available with one specific type of expiration cycle, while with some contracts you are able to choose. For most options traders, this information is far from essential, but it can help to recognize the terms. Below are some details on the different contract types based on their expiration cycle. These are based on the standardized expiration cycles that options contracts are listed under. When purchasing a contract of this type, you will have the choice of at least four different expiration months to choose from.
The reasons for these expiration cycles existing in the way they do is due to restrictions put in place when options were first introduced about when they could be traded. Expiration cycles can get somewhat complicated, but all you really need to understand is that you will be able to choose your preferred expiration date from a selection of at least four different months.
Also known as weeklies, these were introduced in They are currently only available on a limited number of underlying securities,including some of the major indices, but their popularity is increasing.
The basic principle of weeklies is the same as regular options, but they just have a much shorter expiration period. Also referred to as quarterlies, these are listed on the exchanges with expirations for the nearest four quarters plus the final quarter of the following year.
Unlike regular contracts which expire on the third Friday of the expiration month, quarterlies expire on the last day of the expiration month. Long-Term Expiration Anticipation Securities: These longer term contracts are generally known as LEAPS and are available on a fairly wide range of underlying securities. LEAPS always expire in January but can be bought with expiration dates for the following three years. These are a form of stock option where employees are granted contracts based on the stock of the company they work for.
They are generally used as a form of remuneration, bonus, or incentive to join a company. You can read more about these on the following page — Employee Stock Options. Cash settled contracts do not involve the physical transfer of the underlying asset when they are exercised or settled.
Instead, whichever party to the contract has made a profit is paid in cash by the other party. These types of contracts are typically used when the underlying asset is difficult or expensive to transfer to the other party. You can find more on the following page — Cash Settled Options. Exotic option is a term that is used to apply to a contract that has been customized with more complex provisions.
This is a full time style that can be used to trade options, or other financial instruments such as stocks. It's a style often favored by professionals, but has also become more widely used by private individuals in recent years too. This is an intense and time consuming style that requires constant monitoring of the markets during the day. It was was named appropriately because it involves making trades that last no longer than a day — i. For more on this particular style, please read the following page — Day Trading.
This is another style that can be used for trading a range of financial instruments in addition to options. It's one of the most widely recognized styles and can be used by any type of investor or trader.
It's particularly suitable for part time traders who are unable to dedicate several hours a day to their activities, and also for beginners who are not prepared for the intensity of day trading. This style is known as swing trading as the idea is basically to identify price swings and buy and sell appropriately to profit from them.
You can read more about this style on the following page — Swing Trading. This is the style that is mostly used for trading options and futures. It's a relatively low risk style, but it does require a very comprehensive understanding of the mechanics of options and options trading. It's not a style that should be considered by beginners, and it is primarily used by professionals that have the necessary experience and knowledge to be successful.
For further information on this specific style, please visit the following page — Position Trading. Market makers are professionals that are vital to the options exchanges. They ensure that there is always enough depth and liquidity within the market for the traders to be able to execute their desired transactions.
Market makers buy and sell in very high volumes and help traders facilitate transactions if there is no corresponding buyer or seller in the market. This helps to guarantee the market moves efficiently.