This article will focus on the benefits of options trading for newbies in Amsterdam. Before we start discussing these benefits, let us first look at what options are and how they work.
The basics of options trading
First of all: an option is not a financial product per se. It is a derivative, which means it ‘derives’ from something else – in our case, the underlying asset. This underlying asset can be an index (e.g. Dow Jones), a share (e.g. Deutsche Bank), or any other traded product such as foreign currencies (e.g. EUR/USD).
The basic idea behind buying or writing an option is that you benefit from the change in the underlying asset price. The price change is called the ‘movement’, and that’s precisely what we use options for: to manage our (potential) movement(s).
A call option gives you the right to buy assets at a specific price, while a put option gives you the right to sell assets at a specific price. Newbies usually go for calls because these are relatively easy to trade, and they give you more leverage, which means higher profits and higher risks.
An important detail that needs mentioning is that both call and put options expire on a specific date, namely the third Friday of their expiration month.
This means that all trades have time limits – even if this seems obvious, many newbies tend to forget this. Being aware of the expiration date is crucial to successful options trading.
The benefits of options/benefits from options trading
In light of the above, what are the benefits you have when you trade options in Amsterdam? Well, these can be conveniently divided into three main categories: moneymaking, risk management, a bit extra, speculation and hedging. So let us start discussing them one by one.
#1 Money making potential
First and foremost, call and put options come with a very high leverage factor. This means that you only need a small amount of capital to control a relatively large cash value, which gives you much higher returns for your investment. In other words, when buying or writing an option, potential profits are magnified by the leverage factor.
#2 Risk management
The leverage factor, i.e. the high returns, also come with a downside: the risk of losing your investment capital increases. This means that when you lose money on an option contract traded in Amsterdam, you will lose more than if you had invested this same amount without options trading (in other words: trading in cash).
As such, both call and put writing are a precarious business. However, buying options protect against significant price drops because they cost less than investing directly in the underlying asset (the difference between these two prices is called ‘premium’).
On the other hand, their limited period makes them susceptible to quick price movements to drop like a stone.
#3 A bit extra
Because both call and put options expire on a specific date, you can take advantage of this by buying or writing them just before the expiration date. As such, options tend to become more expensive just before expiry.
This is called ‘theta’ (see picture). The idea behind this little trick is that traders close their positions with the most reasonable prices per point. However, you might miss out on some extra cash because you don’t know precisely when they do so.
So if you are willing to assume the risk involved in trading during/just before an option’s expiration month, there can be some additional income available for you with options trading in Amsterdam.
Calls are definitely interesting for speculators because they let you speculate on the rise of prices without directly committing capital. When you speculate on an asset’s future value with options trading in Amsterdam, this means that you expect its price to be higher than its present value when the option expires.
As such, you are willing to bet money against this potential expected price rise. If you are right in your speculation, you make money when exercising the call option you have bought. By doing so, you will be able to buy shares at their lower current price, which is higher than the one when initially buying the call.
#5 Hedging strategy
Calls can also provide exciting opportunities for hedging strategies. When selling an asset that has become too expensive for you or just making a bad investment, it is often possible to reduce your losses by simultaneously buying an equivalent amount of puts on it with options trading in Amsterdam.
For all these reasons – moneymaking potential, risk management and a bit extra – trading in options is highly interesting for newbies. It helps you to make more money with less capital; it protects your investment against significant price movements, but at the same time, it can increase your losses significantly due to its leverage factor.
So whether trading options makes sense or not will depend on how much capital you are willing to invest, what kind of strategy you have in mind, and above all, what kind of trader you are.
As mentioned before, amateurs tend to gravitate towards call options because these seem more straightforward than put options. Therefore, let’s discuss some pros and cons of both types before moving on to practical examples.