The Basics of Option Trading Software

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By: Anne Durrell

Options are what are sometimes called derivatives. In financial terms, a derivative is a type of investment that gets its value from some real thing, like a stock. To put it simply, a derivative is a contract between two parties to exchange with each other value that depends on the behavior of a real stock (or other real good or service). The derivative seller gets money in exchange for an agreement to buy or sell some real good or service at a specific time in the future.

Options are much the same thing: a contract between two parties giving the buyer the right to purchase or sell a real asset at an agreed upon price (called the strike price) at a specific time in the future. The buyer is not obligated to purchase the asset, however. The vendor collects a sum from the buyer. There are two basic types of options: call options and put options.

Call options give the buyer the right to buy the real asset. Put options give the buyer the right to sell the real asset. If the buyer chooses to exercise his option to buy or sell, the option seller is obligated to sell or buy it at the agreed upon price. But the buyer may choose to let the option expire.

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Trading in options is complicated, and it is not easy to predict whether you should buy a put or a call option, for example. Options trading software can help with this, but only if you have some grounding in the derivatives market. Options trading software does things like analyze options, help investors value derivatives, and analyze concepts like covered calls, straddle and spreads.

A covered call is a means for a seller of call options to limit the loss that could result from a short call when an underlying asset price goes above the strike price. A straddle is the situation in which an investor holds both a call and a put with the same strike price and the same expiration date. Why would someone do this? It is a way of hedging bets if an investor believes that the stock price will be volatile, but doesn't know whether it will be going up or down. The only way an investor makes a profit on a straddle is if the stock price moves significantly in either direction. It isn't easy to do, and with stocks that are expected to take off, the market prices options with a higher premium, thus reducing the payoff that would result from a successful straddle. But this might be one of the situations in which options trading software could be of use.

Spreads are option trading strategies similar to straddles, because the investor bets simultaneously on opposing positions at different strike prices. There are many types of spreads, and they can get quite complicated. Suffice it to say that someone using a spread trading strategy probably knows how to use options trading software to help analyze the specific situations in which such a strategy might work.

Options trading is complex, and options trading software can help the investor make decisions on buying or selling options.



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