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When Should You Buy an Option to Make a Profit

December 22, 2020 by Daniels Trading| Futures 101

Options are powerful tools for generating income, hedging risk, and speculating on future market behavior. However, no matter your strategy or financial objectives, options come in only two types: buy (call) and sell (put). Let’s take a look at a few instances when buy options may provide potentially lucrative trading opportunities.

Options 101: The Buy-Sell Dichotomy

An option contract gives the holder a right, but not a duty, to buy or sell a quantity of an asset at a specified price by a forthcoming date in time. In reality, sell and buy options serve very different purposes. Here’s a quick breakdown of essential functionality.

Buy

When you buy an option, you pay a premium for the right to buy or sell an asset quantity at the contract’s strike price by an expiration date. Buying a call gives you the right to purchase an asset at the contract’s strike price; buying a put provides the right to sell at strike. Accordingly, profits grow as price rises above call strikes and when price falls beneath put strikes.

Sell

When you sell an option, you immediately receive a premium in return for pledging to buy or sell at contract expiration. Gains are realized from call or put contracts that expire out of the money.

Learn 21 futures and options trading strategies in this complimentary,  easy-to-read guide. Download Now >>

If selling options can generate instant revenue, then when are buy options a good idea? Here are a few times when purchasing puts or calls can be profitable.

Bullish Bias

As in conventional stock trading, purchasing call options can be an ideal way of buying low and selling high. Given a bullish bias, buying calls is one way of getting in on uptrends or implementing buy-and-hold investment strategies.

For instance, assume that Erin the options trader believes that the S&P 500 is undervalued at $3,250.00 on New Year’s Eve 2020. On Jan. 4, 2021, Erin buys one contract of December 2021 E-mini S&P 500 calls with a strike price of $3,500.00. If the December 2021 E-mini S&Ps trend north of $3,500.00 by expiration, Erin will profit from the call option.

Bearish Bias

Having a bearish bias toward the market reflects the belief that prices are going to fall over a given period. To profit from the decline in value, a trader can buy put options to benefit from a lagging market or asset class.

Assume that Erin decides that the outcome of the 2020 U.S. presidential election is likely to weigh on U.S. equities for the coming year. Accordingly, Erin believes the S&P 500 is overvalued at $3,250.00 on New Year’s Eve 2020. To get in on the action, Erin buys December 2021 E-mini S&P 500 puts with a strike price of $3,000.00 on Jan. 4, 2021. If the December 2021 E-mini S&Ps fall beneath $3,000.00, Erin will profit from the market downturn.

Expiration and Time Decay

For a majority of traders, profits realized from buy options are related to the avoidance expiration and time decay. It’s important to remember that options contracts have a finite shelf life. They can—and often do—expire worthless.

Each option contract is assigned an expiration date, on which it ceases to be traded. If the contract is out of the money on this day, then the contract expires worthless. So it stands to reason that as a contract approaches expiry, its value decreases. This phenomenon is known as time decay.

With time decay in mind, engaging buy options for profit is best done well ahead of expiry. Although the premiums are typically more expensive, the probability of success is significantly higher the further out from contract expiration. No matter whether your market view is bullish or bearish, having enough time to capitalize on a correct opinion is critical if you want to make money trading options.

Is Buying Options for You?

For more information on trading derivative products, check out Daniels Trading’s Futures & Options Strategy Guide. Featuring 21 futures and options trading strategies, this indispensable resource is absolutely free. If you’re interested in getting started in the options markets, be sure to get your complimentary Futures & Options Strategy Guide at Daniels Trading today.

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Filed Under: Futures 101

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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