Have you ever heard of the Vanilla options? This is a very popular tool especially by investors who wish to speculate, even if – in fact – their use could be well used even for hedging purposes and, therefore, for those who want to cover some specific risk.
Attention, in fact, not to confuse the term “options” with “binary options”: the Vanilla options are not a sub-category of binary options, but a completely different form compared to the one so dear to binary trading.
So let’s see what the Vanilla options are, and why this financial instrument could possibly do for you …
What are the Vanilla Options?
Let’s start with a small definition that – perhaps – will be useful for you to clear the field of any doubt. In fact, the Vanilla options are trading instruments through which a person enters into possession of the right to buy, or sell, a given asset, within a specific date, at a pre-established price.
With these characteristics, it is very simple to confuse the Vanilla options with the best known futures. And in fact the terms that could unite the two “worlds” are very present. Fortunately for you, however, there are also elements of divergence that will avoid easy confusion.
For example, when talking about Vanilla options, there is talk of a right to buy or sell, and never an obligation. The futures impose the realization of the transaction when the date comes to maturity, while the Vanilla options are – in fact – an option, an alternative that is granted to the trader.
In addition to this, please note that whoever holds a Vanilla option in a portfolio can not only avoid exercising this right (simply by expiring the option, and “losing” therefore only the option premium) as well as exercising it before the expiry date. if there are margins of convenience. The important thing is therefore to act before the expiration date or in conjunction with this date, as after this time the option will no longer be exercisable.
As if this were not enough, there is also another very important difference: the Vanilla options require the payment of an initial prize. Therefore, the trader who wishes to acquire the right to exercise the purchase or sale must pay a premium, or a sum of money that will not depend on the fluctuations of the price but on other factors, and which can also be understood as ” the price “that you have to pay in order to get the advantage of exercising the option or not when you want. It is certainly not by chance that the concept of premium is completely foreign to the Futures.
How to protect your capital with the Vanilla options
The characteristics that we have summarized above, and in particular the optional nature of the exercise of the option, make this instrument rather valid for those who want to protect their capital. But why?
We try to make a very practical example to be able to know more. Let us assume that we are a trader who has to buy a certain product from a supplier (which we will call Alfa). We also assume that at the moment the Alfa product costs 100 dollars per kilo and that the market in question is very volatile, with a worrying upward trend. In a scenario where the trader does not need the Alfa product today, but in three months, he will expose himself to the risk of facing an unwelcome price increase. But what to do?
The opportunities in the hands of the trader will be mainly two. The first is to buy the Alfa product when you need it, hoping that the price does not rise (or does not go too high). The second is to buy the product now and store it, with all that goes with it.
Well, at this juncture the optimal solution could be represented by the Vanilla options, which will allow the trader to protect himself from market volatility by stipulating an option that will allow him to buy the Alfa product at the current price (100 dollars per kilo) in change of premium payment (for example, 1 dollar). Therefore, the 1 dollar prize is – if we want – the price of the security of being able to pay that particular product at the desired price at a future time.
Now, if in three months the price will be increased, for example, to 115 dollars per kilo, the trader will have the convenience of exercising the option, saving 14 dollars per kilo (i.e. 115 – 110 – 1).
What is important to evaluate when buying Vanilla options?
From the above it is possible to deduce that two are the fundamental elements that can decree the success of an operation that has the Vanilla options as protagonist: the forecasting ability and the evaluation of the prize.
With regard to forecasting capacity, the element is not very significant considering that the objective of the options is precisely that of protecting from less convenient scenarios. For forecasting we can therefore actually understand the ability to analyze the market and try to evaluate the bullish and bearish signals. A capacity that, in short, traders should generally have beyond the financial instrument on which they will focus their efforts.
Turning to the analysis of the prize, here things are a bit ‘more complicated, considering and considering that it is never easy to evaluate the adequacy of the same. One of the simplest methods for everyone to understand is the current price of the asset: even if the premium is expressed in absolute terms and not percentages, it still has a strong link with the price of the asset. In our example, 1 dollar out of 100 dollars of Alfa product have a weight very different from what they could have if the price was 1,000 dollars.
Even the expiration date can affect the premium, for a reason that is easily understandable: the further the option expires, the greater the uncertainty that you can avoid, and the more risky the whole operation would be. It follows that the time factor is directly proportional to the premium: the longer the deadline is extended over time, the more the premium will be raised.
Still with regards to uncertainty, another factor affecting the premium is volatility: the more the Alfa product market tends to be volatile, the higher the premium will go upwards.
The terms of Vanilla options: A bit of clarity!
At this point, we want to move on to a small guide to the terms that you will certainly be exposed in the Vanilla options: it will be very useful to understand how to better evaluate this financial instrument, avoiding technical and notional errors that could lead to large losses. Let’s see together the most common.
Below
It is the object of the transaction (in our example, it is the Alfa product). Of course, we will talk about an “indirect” object, considering that when you buy a Vanilla option you certainly do not buy the product, but only the right to exercise or not the option.
Call Options
The call options are those that guarantee the right to purchase the underlying.
Put Options
On the other hand, put options are the options that guarantee the right to sell an asset.
Strike Price
Also known as the target price, it is the price at which the eventual transaction will occur when the trader chooses to exercise his right (in our example the strike price was 100 dollars).
Spot price
It is the price of the asset at the time of stipulation, which can obviously be different from the strike price (indeed it will be very likely!).
Make speculative trading with the Vanilla options
So far we have talked about the Vanilla options as a useful tool for doing hedging and hedging operations.
However, the use of Vanilla options is not only conservative, i.e. aimed at protecting a business, an investment and so on. The Vanilla options can in fact be purchased not only to be able to defend against price variations as well as to be able to benefit from them, thus making this option a speculative instrument.
Also in this case, to be able to better understand how to use the Vanilla options in a speculative sense, it is useful to give a small example. Let’s assume you want to do Forex trading and that the spot price of the euro / dollar pair is equal to 1.2000. The trader also predicts that the pair will increase in price within a week.
At this point, the investor may choose to purchase a call option on that exchange rate, with this option expiring, of course, equal to one week, and strike price at 1.030. If you buy the option, you will also need to pay a premium that we assume is 50 pip, or $0.005. At this point, if at maturity the market price will exceed the strike price plus the premium, the trader will be able to consider his profitable operation.
What are the advantages of the Vanilla Options?
Now that we know a little more about the Vanilla options, we can try to make a small summary of the many advantages of using them.
Firstly, we can define the Vanilla options as a rather safe investment: they represent not only a tool to protect against market volatility, but also a tool in the hands of speculative traders, able to expose investors to lower risks than to other forms of employment.
Furthermore, the Vanilla options can guarantee the applicability of a discrete variety of strategies, considering that the terms of reference of the option can be completely personalized. Finally, there is the possibility of going against the market, considering that it is possible to foresee a trend different from the one in progress.
Trade with AvaOptions on Vanilla options
We recommend using the advanced platform for Vanilla Avatrade Options!
All you need to do is:
- Open your trading account and select AvaOptions as a platform; click here to open your trading account >>
- The second step is to deposit funds in the account to enter the markets;
- Then download AvaOptions and log in with your credentials.
At this point, you are in your account.
With AvaOptions you can:
- Combine spot assets and options;
- Select the Deadlines from one day to one year;
- Choose to operate with over 40 currency pairs, gold and silver;
- Trading in simplicity with software or web;
- Take advantage of all the advanced risk management tools.
Why choose AvaOptions?
Simply because you can control everything in your hands! Thanks to this platform you can monitor the markets and use your experience and knowledge every day to trade online!
You can also choose the Types of options with any combination:
- Spot
- Call
- put
Choose to invest with a single dynamic platform that gives you the opportunity to create your optimal portfolio of options.
You can choose to invest with Avatrade using the opportunity to buy and sell using the daily, weekly, monthly, annual, or any other deadline.
You can also take advantage of the very professional risk management tool that is useful for analyzing risk, as well as carrying out a portfolio simulation.
Trade on options with limit orders and avatrde!