Long and Short
With options markets, as with futures markets, long and short refer to the buying and selling of one or more contracts, but unlike futures markets, they do not refer to the direction of the trade. For example, if a futures trade is entered by buying a contract, the trade is a long trade, and the trader wants the price to go up, but with options, a trade can be entered by buying a Put contract, and is still a long trade, even though the trader wants the price to go down. The following chart may help explain this further:
| Futures (Buy) | Option (to buy) | Futures (Sell) | Option (to sell) | |
| Entry type | Buy | Call | Sell | Put |
| Direction | Up | Up | Down | Down |
| Trade type | Long | Long | Short | Long |
Limited Risk or Limitless Risk
Basic options trades can be either long or short and can have two different risks to reward ratios. The risk to reward ratios for long and short options trades are as follows:
Long Trade
- Entry type: Buy a Call or a Put
- Profit potential: Unlimited
- Risk potential: Limited to the options premium
Short Trade
- Entry type: Sell a Call or a Put
- Profit potential: Limited to the options premium
- Risk potential: Unlimited
As shown above, a long options trade has unlimited profit potential, and limited risk, but a short options trade has limited profit potential and unlimited risk. However, this is not a complete risk analysis, and in reality, short options trades have no more risk than individual stock trades (and actually have less risk than buy and hold stock trades).
Many day traders who trade futures, also trade options, either on the same markets or on different markets. Options are similar to futures, in that they are often based upon the same underlying instruments, and have similar contract specifications, but options are traded quite differently. Options are available on futures markets, on stock indexes, and on individual stocks, and can be traded on their own using various strategies, or they can be combined with futures contracts or stocks and used as a form of trade insurance.
Key Takeaways,,,
- Options are sold as contracts that detail the underlying asset, the ticks size and tick value, and the expiration date.
- Options offer either the right to buy an asset (“call”) or the right to sell it (“put”), so traders can make deals whether the market is up or down.
- The risk and reward potential of an options contract is in part determined by whether it is a long trade or a short trade.
- Premiums are the fees for buying an options contract, and they vary based on the current profit, volatility, and expiration date.
- To exit an options contract you can sell it or exercise the specified option at the expiration date.
- Symbol: Zomato (only for example) (all are assumptions)
- Expiration date: Expires into the nearest month of the six month contract cycle (Feb., April, June, Aug., Oct., Dec.)
- Exchange: NSE INDIA
- Currency: INR
- Multiplier / Contract value: Rs100
- Tick size / Minimum price change: 0.1
- Tick value / Minimum price value: Rs10
- Strike or exercise price intervals: Rs25 and Rs50 per ounce
- Exercise style: indian
- Delivery: a futures contract
The contract specifications are specified for one contract, so the tick value shown above is the tick value per contract. If a trade is made with more than one contract, then the tick value is increased accordingly. For example, a trade made on the Zomato options market with three contracts would have an equivalent tick value of 3 X Rs10 = Rs30, which would mean that for every 0.1 change in price, the trade’s profit or loss would change by Rs30.
Entering and Exiting a Trade,,,
A long options trade is entered by buying an options contract and paying the premium to the options seller. If the market then moves in the desired direction, the options contract will come into profit (in the money). There are two different ways that an in the money option can be turned into realized profit. The first is to sell the contract (as with futures contracts) and keep the difference between the buying and selling prices as the profit. Selling an options contract to exit a long trade is safe because the sale is of an already owned contract.
The second way to exit a trade is to exercise the option and take delivery of the underlying futures contract, which can then be sold to realize the profit. The preferred way to exit a trade is to sell the contract, as this is easier than exercising, and in theory is more profitable, because the option may still have some remaining time value.