Looking to learn how you can trade options using the vanilla strategy? You’ve come to the right place.
An option strategy involves the acquisition and/or sale of one or more option positions, as well as a possible underlying position. Options strategies can be used to favour bullish, bearish, or neutral moves in the underlying. Neutral techniques can be further divided into bullish and bearish volatility strategies.
Vanilla options (also known as plain vanilla options) allow traders to purchase or sell currencies and other assets in the future at a specified price. This article discusses what the vanilla options trading strategy is, the steps for trading the strategy, and its pros and cons. We will also consider an example that explains how the strategy works.
- 1 What is Options Trading?
- 2 What are Vanilla Options?
- 3 Steps to Follow in Trading Options With Vanilla Strategy
- 4 Pros of the Vanilla Strategy
- 5 Cons of the Vanilla Strategy
- 6 Example
- 7 Wrapping Up
What is Options Trading?
Options trading is the purchase or sale of instruments that offer you the right to buy or sell certain securities at a specific price on a specific date.
An option refers to a contract that is connected to an underlying asset (like a stock or other security). Options contracts are valid for a specific period, which can be as short as a day or as long as a few years.
According to Forbes, S&P 500 options allow traders to bet on the future direction of the benchmark stock index, which is widely regarded as a stand-in for the whole US stock market.
When you purchase an option, you have the opportunity but not the obligation to trade the underlying asset.
What are Vanilla Options?
Vanilla options are financial instruments that enable holders to buy or sell an underlying asset at a predetermined price within a certain time frame. The holder holds the transaction right but is not required to use it. The price is set by the broker.
The term “plain vanilla” refers to an option that has no unique characteristics, making it the most basic sort of options contract.
Traders, businesses, and institutional clients often use vanilla options as a hedging strategy. Index options, FX currency options, bond options, as well as swap and strip options, are all examples of vanilla options.
Although options are normally risky, the vanilla trading strategy helps you trade low-risk financial instruments (i.e. vanilla options). This means that risk-averse traders can boost their returns and also improve their personal finance using this strategy.
Types of Vanilla Options
There are two forms of vanilla options; call and put options. Holders of call options have the right to purchase the underlying asset at a defined price. This is also referred to as the strike price.
More so, put option holders can sell the underlying asset at the same time frame and strike price. The expiry date, which limits the asset’s movement, determines the time frame. The person who sells the option (i.e., the writer) can buy or sell the asset provided the holder exercises his or her right to do so.
There are many trading platforms and brokers. This makes it difficult and confusing to know the reliable platform to invest your hard-earned money. When looking for a trading platform where you can trade options, you need to consider the platform’s interface, functionalities and features, support, and stability of performance.
While carrying out our research, we came across Avatrade. The insightful resources that the platform offers will help you have a deeper understanding of the question; what is options trading? The platform also has an in-depth guide that covers all you need to know about earning through options trading.
Steps to Follow in Trading Options With Vanilla Strategy
Step 1: Determine the instrument’s market overview
A trader has three options for expressing his belief that a particular instrument will rise in value. The first option involves buying the instrument all at once via regular spot trading.
Step 2: Buy a call option
The trader can only lose the premium if he follows this strategy. At any time, this position may be sold. This is the most secure way of conveying a bullish view.
Step 3: Sell a put option
If the price of the instrument is higher than the strike price at the end of the option, it will be worthless, and the trader will keep all of the money they paid for the options upfront.
Pros of the Vanilla Strategy
- Aids in portfolio diversification.
- It makes it possible to use novel strategies (such as time decay, volatility, and lots more).
- Blends well with other options.
- There is a predetermined maximum loss, which means there is less danger.
- It offers different risk measures like delta
- It can be customized to the buyer’s requirements.
Cons of the Vanilla Strategy
- Changes in the underlying exchange rate can lower the option’s value at expiration.
- The purchase of an option comes with a non-refundable premium.
- The total transaction cost may be more than the forward contract price.
- Requires more capital than other types of trading.
Let’s assume that the current price of Stock A is $15. A call option (which will expire in one week) has a strike price of $16 and a premium of $0.18. Each option has 100 shares, so purchasing one costs $0.18 x 100 = $18.
To be profitable, Stock A must rise above $16.18. If the value of stock A remains below $16, the writer keeps the premium. Even if the price climbs to $18, the writer must sell the stock to the buyer at $16.
The relevant calculators and pricing formulas can be found within your chosen broker’s trading platform.
It is important to have an in-depth knowledge of any investment so that you will know what you are getting yourself into. This is why you need to learn before you think of earning. The guide that Avatrade offers will help you in this area.