Options Trading – As Risky As The Reputation?…

Options Trading has a reputation for being extremely risky…

…but this reputation is in large part undeserved. True, option trades ARE extremely risky – even dangerous if you have no idea what you are doing. However, that is true of all forms of offline or online trading, and trading in options is no exception.

While options trading has this reputation among laymen, it is often considered to be a form of risk limitation with professional traders. After all, in what other form of investment can you guarantee the maximum loss you can suffer right at the point where you enter the trade?

Options are contracts that give the purchaser the right to buy or sell an underlying security, such as a stock, a bond or a commodity, at a fixed price and for a fixed time period only. You can find options on underlying securities such as stocks, mutual funds, bonds, commodities, and more.

options trading
Image via Wikipedia

Options trading gives you the chance to exploit a whole range of  market opportunities…

that are unavailable with conventional online stock or forex trading. For example, one class of option trade allows you as the buyer to make money if you expect the market to move strongly in one direction or the other, but you are not sure in which. If you are the seller of position, by contrast, you are betting that the market either goes nowhere directionally and/or the volatility declines.

Actually, options trading can actually lower your risk. For example, whenever you buy an underlying stock, there is always the extremely small, but non-zero, risk that the company can go bust and the stock price can first be suspended and then go to zero. That means that your potential loss is the point difference between the price you entered the stock trade and zero, multiplied by the number of shares you own! If you had done the corresponding option trade by contrast, i.e. buying call options on the stock, your loss would be simply the price you paid for the options.

Where options ARE very risky is where untrained traders go “naked short”, as it is called. In one common example, they sell put options on a stock index future and collect the option premium as payment. This gives the buyer the right to sell the stock index future back to the put option seller at a fixed price, called the strike price. This is fine as long as the underlying index continues to rally and the strike price is basically never reached. However, in one famous example, one hapless options trading punter, who had been happily selling put options  on the FTSE index futures for years and collecting the cash, got badly caught when the entire stock market crashed in 1987, and the option buyers exercised their right to sell their positions at prices MUCH higher than the current market!

However, such foolishness apart, options trading…

… can be an extremely profitable way to trade in stocks, forex, bonds, currencies or whatever.  When used properly, they can actually limit your risk drastically. Option trading can allow you to create positions and exploit market opportunities not otherwise available via standard stock trading methods. Best of all, if you combine options with the underlying instrument, you get to create a whole range of interesting risk profiles.

The key to success in options trading is, as with anything else in life, to study the subject hard before trying to trade and, if possible, begin by paper trading the market. Once you are satisfied that you know what you are doing and have a valid option trading methodology, then you can begin risking real money. Even then, you only trade very small to start with and with money that you can afford to lose. Once you know what you are doing, and your options trading account size show some nice profits, then you can afford to trade progressively larger size for progressively larger profit.

Enhanced by Zemanta

Commodity Trading – An Overview

Commodity Trading

…is strictly speaking the trading of physical commodities  – such as soyabeans, wheat, corn, gold, silver, cattle, oil etc. – or their futures contracts on the established commodity exchanges.

Farmers use commodity trading to lock in favourable prices prior to an ensuing harvest. Hence, there are real commercial reasons for trading in commodities. However, they are also traded for pure speculation by private traders seeking to make a commodity trading profit by speculating in the price movement over their chosen timeframe.

commodity trading
Image via Wikipedia

More than any other type of speculation, such as forex or stock trading, commodity markets involve a very high degree of seasonality. Hence, it is important that the trader be very aware of the underlying cycles affecting the market in question.

That said, commodity trading can be done successfully by…

giving a very high degree of emphasis to the price charts alone. The commodities trade extremely well according to technical analysis methods. For example, Fibonacci price retracements and time cycle analysis work extremely well on commodity charts. So too do other technical indicators such as moving averages, price gaps, support and resistance points, trend-lines and so on.

Trading commodities can be an extremely volatile and unpredictable business because these markets are known for their sudden and sustained price surges and collapses. Compare a long-term commodity chart of something like soybeans or oil to any stock index and you will see the difference. Hence, it is vital in commodity trading that you are extremely disciplined in your approach and employ strict money management rules. A good stop loss order, placed in the market at the time you place your trade, is a must.

Traders also play the spreads between commodities, which is an extremely popular form of commodity trading, and which effectively multiplies the range of profit opportunities hugely. Examples of spreads is the wheat-corn spread,  where traders speculate on the relative price of one to the other. Other spread opportunities occur in the price differentials between different delivery months of the same commodities’ futures contracts. Hence, you might buy the contract nearer to expiration and sell the one further out with the expectation that long-term prices of that commodity will fall with respect to near term prices.

Once you also realize that there are active options contracts in all the major instruments, it becomes clear that commodity trading is a very desirable niche within the universe of speculation.

As with all forms of trading, mental and financial discipline are key factors to success  in commodity trading. Given their extreme volatility, it is paramount that you have a proven method before you ever speculate a single dollar in these often unpredictable markets.

You must also remember that these are real physical products involved, and they can literally be delivered if you fail to close out your position before the expiry of the commodity future or option contract. Otherwise, it can result in a truck pulling up outside your house with your delivery of soybeans, live cattle or cocoa – depending on what you have been trading. This has been known to happen!

That said…

The opportunities present in commodity trading are huge and exciting.

These are markets that see some real action. There are fast moves that can make huge profits for you IF you are on the right side of them. There are also sustained long-term trends that can be very profitable for system trading.  You also have the pleasure of knowing that you are trading in real world items, which can give your commodity trading a whole new meaning.

Enhanced by Zemanta