Directional Trades with Options
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Maybe you have already heard about an option trade being directional or non-directional. What does it mean? In short, this distinction is about how much the trade is exposed to movement in price of the underlying security. This article explains directional trades. Here you can find the second part concerning non-directional option trades. Directional trades are the most common things people do in the markets. You have two basic possibilities. Here you can read about directional trades with stockswhich is pure and simple buying and selling of stocks.
When you expect a stock to rise you are bullishyou buy it and if you are right, you make money. When you expect a stock to fall you are bearishyou sell it short and if you are right, you make money. If you are wrong and the stock goes in directional trading with call options other direction, you lose money. If the stock stays at the same level, you neither make nor lose any money.
This is not always true with options as you will soon see. You can place similar directional trades using options. In other articles we have explained why calls tend to increase in price when the underlying stock goes up, while puts tend to appreciate when the underlying goes down. So instead of buying the underlying stock, you buy a callwhich is an example of a directional trade directional trading with call options bullish bias.
Or instead of selling the underlying stock short, you can buy a put optionwhich is a directional trade with bearish biasas a put increases in price when the underlying asset goes down. Stock goes up by 5, you hold 1, shares, and you make 5, dollars. Stock goes down by 3 dollars and with 1, shares you lose 3, dollars. But unless the call is deep in the money and has only little time valuethe amount by which the call option will rise is not equal to the amount by which the underlying stock rises.
If a call option is in the moneyits intrinsic value increases by the same amount as the underlying stock increases. But at the same time, as the option is getting deeper in the money, its time value declines see why. This mechanism also works to the other side.
If the underlying stock falls further and the option directional trading with call options out of the moneyits time value starts to decrease again the further out of the money, the lower time value.
Deep in the money options move almost as fast as the underlying, while out of the money options move very slowly. This is also valid for put optionsonly the direction is the opposite put option appreciates when underlying stock falls. Nevertheless, the other factors usually still have some impact. Buying a call option long call or buying a put option long put are the two simplest directional trading with call options positions you can create with options.
Besides, you can also sell a call short call, a bearish position or sell directional trading with call options put short put, a bullish position. It is important to know the terminology and be aware of the difference between movement in price of an option and movement in price of its underlying. Unlike with stocks, long does not always mean bullish and short does not always mean bearish with options read more here.
Besides trades with single options there are also many different option spreads like bull call spread directional trading with call options, bull put spreaddirectional trading with call options put spreador bear call spread and even more complicated combinations of multiple optionswhich in sum create a bullish or bearish exposure to the underlying security.
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Macroption is not liable for any damages resulting from using the content. No financial, investment or trading advice is given at any time. Home Calculators Tutorials About Contact. Tutorial 1 Tutorial 2 Tutorial 3 Tutorial 4. Directional Trades with Options. Single Option and Option Spreads.