Before widespread availability of computers and internet access, anyone who wanted to trade stock options needed a massive brokerage account, approval from financial authorities, plenty of specific training, and usually a brokerage license. As recently as the 1980s and early 1990s, few individuals were qualified to trade these complex instruments, and even fewer wanted to. The entire segment of the trading world was one reserved for institutional clients, experienced brokers, and the brave few individuals who were willing to risk large sums of money with little guarantee of any return.
Then, after computers become commonplace and online trading blossomed as a practice for ordinary folks who wanted to try their hand at other kinds of investing, the entire situation changed. Fast-forward to 2020, and many like-minded investors buy and sell currency and commodity options from the comfort of their homes on a daily basis. Here are some of the key facts that investors should know about how the practice become so popular and how to use an options trading platform to buy and sell these versatile financial instruments.
Understanding the Basics
Options are contracts to purchase or sell a designated dollar value of a commodity, like oil or gold, at a specific price on a fixed date in the future. For example, you could purchase a contract to buy 1000 barrels of crude oil on September of 2000. Note that September is actually a specific date because all contracts expire on the third Friday of the month.
Read the Official SEC Booklet
Since trading in this niche has become so popular, the Securities and Exchange Commission (SEC) has issued an official booklet to educate potential investors about how to buy and sell them. The name of the publication, which your broker will give you free of charge when you open an account, is Characteristics and Risks of Standardized Options. It’s also available for a no-cost download at many websites. It clearly explains all you need to know to begin, and even includes a detailed section on how to keep accurate tax records and manage risk.
Before you buy or sell a single contract, become familiar with how transactions work and what some of the key terms are. Here’s an illustrative example. Suppose you believe, based on your analysis of the marketplace, that the price of crude oil is about to rise in value to $60 per barrel (BBL is the common abbreviation for barrel). You can take advantage of this knowledge in a number of ways, either by buying oil directly on an exchange or buying oil options. If you opt for options, you might go onto the trading platform and purchase a call contract.
That contract would state the expiration date, the strike price, the number of barrels it gives you the opportunity to buy, and the name of the commodity, in this case crude oil. Suppose today is January 5th, 2021, and you purchase a February call contract for 1000 BBLs at $52 dollars per barrel. Note that $52 is the strike price. Once you purchase the contract, you have the power to buy 1000 barrels of petroleum at $52 per barrel any time before the expiration date, which is on the third Friday of February 2021. Note that you can purchase at that price, $52 per unit, regardless of what the current market rate is at the time you decide to buy.
If your prediction is correct, and the price rises to $60, you stand to gain plenty of profit. In fact, you could immediately redeem the contract for 1000 BBLs at $52 and immediately sell the commodity on the market for $60 per BBL, netting a profit of $8 times 1000, or $8,000. You can trade most currencies and commodities as options contracts.
Get Approved and Open an Account
Once you’ve gone through the self-education phase, it’s now time to find a trading platform and brokerage that will fit your trading and long-term financial goals. Additionally, you’ll need to get approved by your broker to trade. Every firm has its own rules about who can trade and what their buying and selling limits actually are. This makes sense because the practice is much more complex than typical transactions. Many brokers will ask about your experience in the field and will end up setting specific trading limits based upon your knowledge and the size of your account balance, which as the more you can afford to invest, the more you stand to gain or lose with the shifting of the market.
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