Options & Derivatives Trading

direct option

What are direct options?

Outright options are options that are bought or sold individually. This option is not part of a spread betting or other type of option strategy that buys multiple different options.

key takeaways

  • Outright options are options purchased separately and are not part of a multilateral options transaction.
  • Outright options, which can include both calls and puts, can refer to any underlying option purchased on a single underlying security.
  • Outright options are traded on exchanges similar to securities assets such as stocks.

Learn about direct options

Outright options, which can include both calls and puts, can refer to any underlying option purchased on a single underlying security. They are the most basic form of options trading.

Outright options are traded on exchanges similar to securities assets such as stocks. In the United States, there are many exchanges that list all types of outright options for investors. As such, the options market will see activity from both institutional and retail investors.

Institutional investors can use options to hedge risk exposure in their portfolios. Managed funds can make options a central focus of their investment objectives. Many leveraged call and put strategies also rely on the use of options.

Retail investors can choose to use options as an advanced strategy or as a cheaper alternative to investing directly in the underlying asset. Gaining access to options trading is often more complex and requires additional brokerage access. Most brokerage platforms require a margin account and a minimum deposit, usually over $2,000 to trade options.

Institutional and retail investors who use outright options typically focus on call or put options. Calls and puts are usually contracted in increments of 100 shares. This means that one option controls 100 shares of the underlying stock. Option premiums are quoted per share; a $0.50 option will cost $50 to purchase ($0.50 x 100 shares).

Spreads and exotic options involve the use of more advanced options trading tools and are not considered outright options. Spread strategies involve the use of two or more options contracts in unit trades. Exotic options strategies can be constructed in a number of ways. Exotic options may include contracts based on a basket of underlying securities with various options contract conditions.

Outright call and put options

Outright options are call options or put options. Traders buy one or the other, but not both, as a directional bet on the direction of the underlying asset, or to hedge another non-options position. Holding more than one option on the same trade is not eligible for outright options trading.

A call option gives the buyer the right to buy the underlying security at a specific strike price. For American-style options, the buyer can exercise the option at any time before the expiration date. The strike price is the price at which the buyer can acquire ownership of the subject matter, and exercise is to take advantage of this opportunity. In exchange for this right, the option buyer pays a premium to the option seller. The option seller can retain the premium, but if the buyer exercises the option, it is obligated to sell the underlying security to the bullish buyer at the strike price.

A put option gives the buyer the right to sell the underlying security at a specific strike price. In exchange for this right, put option buyers pay a premium to option sellers. Option sellers can keep the premium, but if the buyer exercises their option, they are obligated to buy the underlying from the put buyer at the strike price.

Both call options and put options have expiration dates. American-style options can be exercised at any time before expiration, while European-style options can only be exercised at expiration.

Example of a direct option

Suppose investors are bullish on Apple (AAPL) and see the stock price rising in the coming months. If investors wanted to buy outright options, they would buy call options. A call option gives a bullish buyer the right to buy Apple at a specified price.

Assume that the stock is currently trading at $183.20 on May 22. Investors believe the stock could trade above $195 by August.

Looking at the call options available, traders must choose how they want to proceed.

A call option chain for Apple Inc. (AAPL).
Yahoo Finance

They can buy options that are already in the currency. For example, they could buy an August call option with a $170 strike price at $19.20 (ask). This will cost the investor $1,920 ($19.20 x 100 shares). If the stock price did reach $195, the option would be worth about $25 and the option buyer would have made a profit of $580 (($25 – $19.20) x 100 shares). They can also exercise their option to receive shares at $170 and then sell them at the current market price (in this case theoretically $195).

The risk is that traders could lose as much as $1,920 if Apple stock falls. The biggest losses will occur if it falls to $170 or below. Traders will lose the entire premium. Although, they can sell the option before then to recover some of the option cost.

Another possibility is to buy near-the-money or out-of-the-money call options. These are lower cost, but have their own drawbacks and opportunities.

Suppose a trader buys a $185 strike option at $9.90 (ask). It cost them $990.

If the stock is trading near $195 at expiration, the option should be worth around $10. This gives the trader a $10 profit, which (minus the commission) means they may lose some money. In other words, the trader can exercise the option and take control of the stock at $185. They can then sell them on the stock market for $195, making a profit of $1000 ($10 x 100 shares), but they pay $990 for the option, so their net profit is $10.

To make money on this deal, the price needs to rise above $195 before or at expiration. If $200 is reached, the trader will make a profit of $510. The option was worth $15 ($200-$185), but they paid $9.90 for it. Profit per share is $5.10, or $510 ($5.10 x 100 shares). The price needs to rise more than the previous example.

Comparing the two cases, the first one is obviously much more expensive. Unless the stock falls below $170, the first option will have value at expiration. This means that traders may recoup some of the option cost even if the price does not rise (or fall) as expected.

On the other hand, if the stock price does not rise above the strike price of $185, the second option will continue to depreciate and expire worthless. Even if the stock does rise above the strike price, the trade could still be a loss even if the price reaches its $195 target.Price will need to move up The order in which the trader makes money in the second case is $195.

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