Traders Tips
by Gerard on February 8, 2016

TorOption: Introduction to Vanilla, Exotic, and Binary Options

Trading financial options can be risky, but can also be very rewarding. This article introduces various types of options available to investors.

Vanilla Options

These options, also known as “plain vanilla options,” have standardized contract sizes, strike prices, and expiration dates. They trade on standard exchanges. By looking at option chains for a specific asset (such as a stock), traders can see all the information about which strike prices are available and for which dates.

Moreover, volume, open interest, and bid and ask prices are provided. Some of these options expire in the near term, while others have expiration dates a year, even two, from now.

With vanilla options, traders can either go long or short. By going long, traders either bet on asset’s rise (by buying a call) or on its decline (with a put). For this, premium must be paid. If, for instance premium on an option of a stock is 10 cents, it means that $10 needs to be paid for one option contract. (Note that for different asset types, there are different contract sizes.)

On the opposite side are option writers (short sellers). Their aim is to earn money (premiums) from writing options. They hope that the price of an asset for which they wrote a contract will not go up (if they’re call writers) or go down (for put writers). Their aim is to see the contracts expire worthless.

Some of these writers are “covered,” which means that they actually own the asset for which they wrote a contract. For example, if an investor owns 500 shares of ABC stock, he or she may write 5 contracts and still be covered. There are also so-called “naked writers” who write options without owning the asset. Their strategy is more risky than covered writing.

Options can also be divided into either American or European. American Options can be sold (or bought back) prior to their expiration, so the holders don’t have to wait until the expiration day to take profits or cut short losses.

In fact, most option need to be sold, otherwise the long buyers will need take possession of underlying assets at the strike price of the option (if these expire in-the-money), and the sellers will need to deliver the assets for which the options were written.

On the other hand, European Options are different since they can only be liquidated at expiration. Thus, they give less flexibility to their buyers and sellers.

Exotic Options

These options have more complex payouts than vanilla options. One example is the Chooser Option. During the contract period, the owner of this option can actually choose whether he or she wants it to be a put or call option. That’s not possible at all with other option kinds. Another kind is the Asian Option. Its eventual payout depends on the average price of the underlying asset during contract’s life.

There’s also the Bermuda Option. It’s more of a combination between American and European Options. The Bermuda Option can be exercised during life of a contract, but only on certain dates. This is different from the American Option which can be exercised at any time, or the European Option that can’t be exercised prior to maturity date. Still another exotic option is the Balloon Option. Its payout can actually increase as certain threshold levels increase.

There are more kinds of such combinations available and new ones are being developed. The best way to understand them is to carefully read contract terms. Some of these exotic options may not be even available to retail investors. But, the markets have developed another kind of options (actually related to exotic options), which are also easy to understand and trade: the Binary Options.

Binary Options

Today, accessing Binary Options trading is easy for retail investors. Reputable online Binary Options brokerage houses such as TorOption offer a variety of these options on multiple asset classes including international stocks and indices, commodities, and currencies.

With these options, traders either choose a Call or a Put. The risk is limited to the premium and the payout, in many cases, is set at the time of purchase. There are short-term options that last 60 seconds or 5 minutes. Traders can also go for longer term contracts.

In addition, other kinds such as One-Touch Options are available. With these, the price doesn’t need to finish at a certain level, but rather needs to touch a specified target during the option’s time. Similar to these are Ladder Options. With these, once a price reaches a certain level, the traders are guaranteed some profits. At times, if the price goes into higher ladders, the profit increases.

Pair Options can also be traded. Here, the traders can bet on one asset versus the other. An example is betting on Facebook’s rise against Twitter’s, or vice versa.

Binary Options are a new way to trade the markets. From a single Binary Options account, with a broker such as TorOption, multiple markets can be traded easily.

By Gerard

Gerard contributes his 10 years of experience to the Forex Trading Bonus team by reviewing different brokers, outlining regulation, and reporting on the most important news in the industry. His brief stint in the Bank of England gives him the edge over many other writers to deeply analyze a policy change and come up with a distinct result that could come from it.

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