A Guide to Vanilla Options in Stock Trading
There are many kinds of stock trading. Day traders trade stocks within a few seconds, while swing traders hold their position for several days. Some people invest in stock trading for the long-term (but still buy and sell stocks within a few days or weeks), earning dividends and capital gains.
Of the many kinds of stock trading, there are also two kinds of options trading. One is Vanilla options, and the other is Binary options. Here we will be focusing on Vanilla options.
What Are Vanilla Options In Stock Trading?
Vanilla options are a type of contract giving traders the right to buy or sell a specified amount of an instrument, at a specific price, at a pre-defined time.
Stock traders can control several things when trading vanilla options. For starters, the trader has the power to decide on the amount of a specific security or asset that they will trade and at what price. Traders also have the option to choose how long they would like to hold onto their investments. For example, traders could buy an option for one day, seven days, 30 days, or even 365 days from now. Lastly, each purchase is made at a pre-determined price that they cannot alter once it is set in stone unless otherwise stated by contract specifications.
Vanilla options are frequently used as alternative investing tools due to their high flexibility and familiarity with stock traders. These exchanges allow investors to go “long” or “short” for a specified amount of time. Going long indicates that the trader thinks the value of an asset will rise in worth during its due course, while going short implies that he believes it will drop in the price instead.
Though most vanilla options are not exercised (meaning they’re not traded at their pre-specified price) and expire without being traded, they can renew some options according to contract specifications. There’s also a tiny chance that traders could benefit from holding onto a vanilla option beyond its original date since their contracts sometimes renew automatically or have other unique qualities unique to each investor.
How To Trade Vanilla Options
To trade basic vanilla options, the buyer must put up either 100% or 50% of the total value as a down payment. The rest of the balance is paid to the seller upon settlement.
The price at which an option can be exercised, also known as its “strike” price, is decided before each contract’s expiration date and is independent of put or call options. Every option comes with a pre-defined set time after which it expires and cannot be traded again until re-opened by the original owner. Most vanilla exchanges expire between 9:00 AM and 5:30 PM EST during trading days (Monday through Friday) and must be renewed before expiration to avoid losing all their benefits.
Benefits And Downfalls Of Using Vanilla Options
Vanilla contracts are highly flexible since they can either benefit or cost investors money. However, this means that certain risks need to be considered before any investment decision is made. Even though there are circumstances where an option could be re-opened automatically under certain contract specifications, it’s best to consult your financial advisor first before initiating any transaction involving the exchanging of money.
Some other benefits include:
- Options can be bought or sold at any point during their stated lifespan.
- Traders can undertake proper market research regarding current market conditions before investing in anything.
- Each investor has the power to decide which assets they will trade and how long they want them for (up until their pre-defined expiration time).
Disadvantages of Using Vanilla Options Trading:
Vanilla options are not always a good idea since each specific trade needs to be sufficiently analysed before making any decision. Even though there are ways of avoiding adverse outcomes, it can sometimes come at the price of losing out on future gains. A few risks associated with using this method include:
- Most vanilla options are not exercised and expire without being traded, so traders must renew some contracts periodically to retain their benefits.
- Prices paid for trading contracts may fluctuate depending on market conditions, whether the contract has value or if its period has expired.
- Without proper training or knowledge of what you’re doing, it’s virtually impossible to guess which direction prices might go in the future, thereby increasing your chances of loss significantly.
Trading vanilla options come with a set number of pros and cons, but it does provide investors with a lot of flexibility. Proper market analysis is necessary if you’re thinking about trading vanilla options to avoid loss or disappointment.