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Understand Futures & Options in Trading Market With a Mask

8


What is Options?

In the other scenario, again, you were walking on the street and went to the store.

This time, the store manager told you that he is selling a coupon for people to buy masks after 3 days. Currently, the market price of the mask is $2.

He offered that you can pay $1 for the special coupon, then after 3 days, you can decide whether you want to buy it at the same price.

3 days after, if the price of the mask is more than $2 and you still want your mask, then you can use the coupon.

If the price of the mask is below $2, then you can forget about the coupon and buy the mask at the current market price.

And if the price goes up to $100, then you should have 2 choices :

  • Use the coupon to buy a mask at $2 and sell it to someone else at $100. Then you get $100(Revenue) — $2(Cost) — $ 1 (Coupon) = $97 as Profit
  • Sell the coupon to someone else at least $98. Then you get $98(Revenue) — $1 (Coupon) = $97 as Profit

Either way, you will get profit from this strategy.

In Market Context

Options are a right without an obligation to buy or sell equity or index. Different from Future Contracts, investors can make their decision on whether they want to executive their obligation when it expires.

Its primary function is to minimize the loss at a certain level, and potentially bring the infinite revenue from the trade.

In the above mask example, your greatest loss is the $1 for the coupon. But your revenue can go ups to the sky — who knows mask could cost tomorrow?

Benefit

Options use leverage to maximize returns and set the lost as a predefined level.

Example

You are currently holding a stock with a $150 market value. You predict the stock price will go down soon, so you buy an Options($150) to action with $5 cost.

  • If the stock price goes down <= $150, you would only lose $5 for the Options.
  • If the stock price goes up to $1000, then you would forget about the Options and directly gain from the increased value of stocks.

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