Options Spread Bets An option gives the owner the right to either buy (this is called a call option) or sell (this is called a put option) at an agreed price and agreed time in the future. Like ordinary spread bets the price of the option will be "live" (tradable) right up to the option date. The price of an option is worked out by taking account of the strike (price where option kicks in), volatility (average movement) of the instrument the punter would like to deal in and the amount of time the option runs for. Confusion is possible in options, because there are two usages of the terms 'long' and 'short'. One usage refers to the overall market, for example, the price of gold. If you think the price is going to go up, you want to buy, or go 'long', the market. As you will see below, you can do this with options by either buying calls or selling puts. The other usage refers to individual products, like options. If you buy an option, you are said to be 'long' of it. So if you have purchased both a put option and a call option, you are both 'long' puts and 'long' calls. You need to be careful exactly what you are referring to. Our strong advice is that you only ever buy, or go long, options. Selling options exposes you to unlimited losses, whereas when you buy options, you can never lose more than you have already paid for them. Buying a Call Option As we said, a call option gives the owner the right to buy at an agreed level on an agreed time in the future. If the price moves above the strike price by more than the cost of the premium you have paid, you will make a profit (see example 1). If the price stays below the strike price you just lose the premium (the cost of the option). Example 1 Mr G likes the look of gold and decides he would like to buy a 3 month call option. Let's take the start date as January 1st and the expiry date as March 1st (so there are only 2 months life left in the option). For this example we will use 1 US$ as a point movement with the price of gold at US$270 per ounce. The March 1st US$300 strike price gold calls are US$ 9-10. There are a number of different possible strike prices for March 1st expiry. An option on a different strike price will cost a different amount. Here you can buy the US$300 March gold calls at US$10. On the expiry date you will be long of gold at US$300, plus it will have cost you US$10 to have that right. So if the price is above US$310 (your call price of US$300 plus the US$10 you paid for the call) you will make a profit. If the price is between US$301-310 your loss will be the difference between that level and US$310. Remember, your maximum loss can only be the premium you pay when you buy an option, in this case US$10. Mr G paid US$10 for the US$300 March gold calls, the expiry price in March is US$304. His stake is £10 a point. Result 1 Loss   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 March expiry 304 Difference -6 Result -6 x £10 stake = £60 loss     Buying a Put Option A put option gives the owner the right to sell at an agreed level and agreed time in the future. If the price moves below the strike price by more than the cost of the premium you have paid, you will make a profit (see example 2). Result 2 Mr G paid US$10 for US$300 March gold calls and the expiry price is US$350. His stake is £10 a point. Profit   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 March expiry 350 Difference +40 Result +40 x £10 stake = £400 profit     If you are keen to really get involved in the selling of options seek professional advice and guidance. Even if you feel you are completely clear about the way options trade we again suggest where possible to paper trade (practice trade) for a reasonable period so you completely understand the risks involved. Result 3 Mr G paid US$10 for the March US$300 gold calls and the expiry price is US$270. His stake is £10 a point. Loss   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 But as the price is not above 310 Mr G will not exercise (take up his right to buy at 300) so he will lose only the US$ 10 premium paid for the option. Result -10 x £10 stake = £100 loss     Remember - when buying an option, whether it is a "call" or a "put" the maximum loss you can make is the premium you pay for the option, if events go against you. Warning - if you sell an option there is no limit on your possible losses if events go against you. Remember - option spread bets are also "live" and if the market moves your way it will reflect the movement in the option price. Result 4 Mr G paid US$10 for the March US$300 calls. The gold price moves within a week to US$310. In this case Mr G decides to sell his option and take profit, the option bid price has moved from US$10 to US$30 to reflect the move in the gold price. Profit   Mr G long US$300 March calls at US$10 Option price now 30 Difference +20 Result +20 x £10 stake = £200 profit     Example 2 Mrs F thinks the price of the £ against the US$ will fall in the next month or so. It is January 3rd and the £/US$ is currently 1.5550. She decides to buy the March (expiry March 1st at 11am) 1.50 puts. For this example a point movement equals 0.10 of a cent. The put option quote is 2.00-2.20. She buys the put at 2.20 staking £10 a point. Result 1 Sterling falls rapidly to 1.53 within a week and the bid price of the option moves up to 3.10. She decides to take profit. Profit   Long put March 1.50 £ US$ at 2.20 Option price now 3.10 Difference 1.10 = 110 points 110 x 0.10 = 11 Result 11 x £10 stake = £110 profit     Result 2 Sterling stays roughly unchanged and is still 1.55 on expiry. The option is not exercised (taken up). Therefore the premium paid is lost. Loss  2.20 = 220 points 220 x 0.10 = 22 Result -22 x £10 stake = £220 loss   Result 3 Sterling falls to 1.49 by March expiry. Mrs F paid 2.20 for 1.50 puts therefore her "real" price would be 1.4780 (1.50 - 2.20/100 = 1.4780). Loss   Short at 1.4780 March expiry 1.4900 Difference 1.20/100 1.20/100 = 120 points 120 x 0.10 = 12 Result -12 x £10 stake = £120 loss     Result 4 Profit   Sterling falls on expiry to 1.48 against US$ =1.50 - 2.20/100 premium of option = 1.4780 Therefore position is:- Short 1.4780 Expiry price 1.47 Difference +0.8/100 0.8/100 = 80 points 80 x 0.10 = 8 Result +8 x £10 = £80 profit           Options Spread Bets An option gives the owner the right to either buy (this is called a call option) or sell (this is called a put option) at an agreed price and agreed time in the future. Like ordinary spread bets the price of the option will be "live" (tradable) right up to the option date. The price of an option is worked out by taking account of the strike (price where option kicks in), volatility (average movement) of the instrument the punter would like to deal in and the amount of time the option runs for. Confusion is possible in options, because there are two usages of the terms 'long' and 'short'. One usage refers to the overall market, for example, the price of gold. If you think the price is going to go up, you want to buy, or go 'long', the market. As you will see below, you can do this with options by either buying calls or selling puts. The other usage refers to individual products, like options. If you buy an option, you are said to be 'long' of it. So if you have purchased both a put option and a call option, you are both 'long' puts and 'long' calls. You need to be careful exactly what you are referring to. Our strong advice is that you only ever buy, or go long, options. Selling options exposes you to unlimited losses, whereas when you buy options, you can never lose more than you have already paid for them. Buying a Call Option As we said, a call option gives the owner the right to buy at an agreed level on an agreed time in the future. If the price moves above the strike price by more than the cost of the premium you have paid, you will make a profit (see example 1). If the price stays below the strike price you just lose the premium (the cost of the option). Example 1 Mr G likes the look of gold and decides he would like to buy a 3 month call option. Let's take the start date as January 1st and the expiry date as March 1st (so there are only 2 months life left in the option). For this example we will use 1 US$ as a point movement with the price of gold at US$270 per ounce. The March 1st US$300 strike price gold calls are US$ 9-10. There are a number of different possible strike prices for March 1st expiry. An option on a different strike price will cost a different amount. Here you can buy the US$300 March gold calls at US$10. On the expiry date you will be long of gold at US$300, plus it will have cost you US$10 to have that right. So if the price is above US$310 (your call price of US$300 plus the US$10 you paid for the call) you will make a profit. If the price is between US$301-310 your loss will be the difference between that level and US$310. Remember, your maximum loss can only be the premium you pay when you buy an option, in this case US$10. Mr G paid US$10 for the US$300 March gold calls, the expiry price in March is US$304. His stake is £10 a point. Result 1 Loss   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 March expiry 304 Difference -6 Result -6 x £10 stake = £60 loss     Buying a Put Option A put option gives the owner the right to sell at an agreed level and agreed time in the future. If the price moves below the strike price by more than the cost of the premium you have paid, you will make a profit (see example 2). Result 2 Mr G paid US$10 for US$300 March gold calls and the expiry price is US$350. His stake is £10 a point. Profit   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 March expiry 350 Difference +40 Result +40 x £10 stake = £400 profit     If you are keen to really get involved in the selling of options seek professional advice and guidance. Even if you feel you are completely clear about the way options trade we again suggest where possible to paper trade (practice trade) for a reasonable period so you completely understand the risks involved. Result 3 Mr G paid US$10 for the March US$300 gold calls and the expiry price is US$270. His stake is £10 a point. Loss   Mr G paid US$10 for 300 March calls Long at 300 + US$10 premium paid = 310 But as the price is not above 310 Mr G will not exercise (take up his right to buy at 300) so he will lose only the US$ 10 premium paid for the option. Result -10 x £10 stake = £100 loss     Remember - when buying an option, whether it is a "call" or a "put" the maximum loss you can make is the premium you pay for the option, if events go against you. Warning - if you sell an option there is no limit on your possible losses if events go against you. Remember - option spread bets are also "live" and if the market moves your way it will reflect the movement in the option price. Result 4 Mr G paid US$10 for the March US$300 calls. The gold price moves within a week to US$310. In this case Mr G decides to sell his option and take profit, the option bid price has moved from US$10 to US$30 to reflect the move in the gold price. Profit   Mr G long US$300 March calls at US$10 Option price now 30 Difference +20 Result +20 x £10 stake = £200 profit     Example 2 Mrs F thinks the price of the £ against the US$ will fall in the next month or so. It is January 3rd and the £/US$ is currently 1.5550. She decides to buy the March (expiry March 1st at 11am) 1.50 puts. For this example a point movement equals 0.10 of a cent. The put option quote is 2.00-2.20. She buys the put at 2.20 staking £10 a point. Result 1 Sterling falls rapidly to 1.53 within a week and the bid price of the option moves up to 3.10. She decides to take profit. Profit   Long put March 1.50 £ US$ at 2.20 Option price now 3.10 Difference 1.10 = 110 points 110 x 0.10 = 11 Result 11 x £10 stake = £110 profit     Result 2 Sterling stays roughly unchanged and is still 1.55 on expiry. The option is not exercised (taken up). Therefore the premium paid is lost. Loss  2.20 = 220 points 220 x 0.10 = 22 Result -22 x £10 stake = £220 loss   Result 3 Sterling falls to 1.49 by March expiry. Mrs F paid 2.20 for 1.50 puts therefore her "real" price would be 1.4780 (1.50 - 2.20/100 = 1.4780). Loss   Short at 1.4780 March expiry 1.4900 Difference 1.20/100 1.20/100 = 120 points 120 x 0.10 = 12 Result -12 x £10 stake = £120 loss     Result 4 Profit   Sterling falls on expiry to 1.48 against US$ =1.50 - 2.20/100 premium of option = 1.4780 Therefore position is:- Short 1.4780 Expiry price 1.47 Difference +0.8/100 0.8/100 = 80 points 80 x 0.10 = 8 Result +8 x £10 = £80 profit