8/3/2019 Advantages of Call Option

1/4

The Advantages of Call Trading OptionsThere is a low potential risk not like other option derivatives

such as futures. Generally, you can only lose the amount you

have invested and nothing more when you buy and optioncontract.

Options allow you to have leverage on your investment

efficiently taking control over the fortunes of an underlying asset

for a small cost of purchasing the asset itself. If you are going to

keep the option until its expiry date and it is in-the-money, you

would receive the same benefit if you had bought the stocks that

the options controlled.

It is flexible. There are various options combination you can

take out because there are a lot of option exercise prices and

expiry dates. Plus, you can create options positions as well as

purchase them. With the right conditions, you can sometimes

take a small risk trading chance because of these variables.

The Disadvantages of Call Trading Options

The key disadvantage to buying call options is that it will expireworthless if you buy it and the underlying security does not move

higher.

Additionally, in the wrong hands, options can be very dangerous.

Some traders may speculate that the market is going to move

lower and sell a boatload of calls only to watch the stock move

higher and put them on the hook for delivering the shares.

8/3/2019 Advantages of Call Option

2/4

How Is Open Interest Different From Volume?

Open interest is totally different from volume because volume transacted,

like in stock trading, is simply a measure of how many times a futurescontract has been traded for the day. Volume do not distinguish between

opening transactions and closing transactions, neither does it show the totalnumber of contracts that has been opened and still active in the market.Volume and open interest tell completely different stories about a futurescontract and give futures traders a more complete idea on the liquidity of a

futures contract.

One more important difference between open interest and volume is thatopen interest is cumulative while volume isn't. Volume only indicates the

number of contracts traded within a single day and then resets the next daywhile open interest does not reset. The table below shows the change in openinterest and volume of an actively traded futures contract on a daily basis.

end of Day... Trades Open Interest Volume

1John Buys 10 contracts (the Long)

Peter Sells 10 contracts (the Short)10 (+10) 10

2John Buys Another 20 contracts (the Long)

Mary Sells 20 contracts (the Short)30 (+20) 20

2 John offsets 20 contracts 10 (-20) 20

As you can see in the example above, volume merely records the number ofcontracts that gets transacted daily without regards to whether it is an

opening or closing transaction while open interest is a running balance of the

number of open contracts in the market that are still due for finalsettlement.

Cash Vs physical settlement

Consider a speculator who bought the futures at 40 and has seen the price rise to 55before expiry. He would have received 15 as mark-to-market gains during the course ofthis price rise, and under cash settlement, there is nothing more to be done.Under physical settlement, the speculator has to undertake one extra sale transaction inthe cash market to complete the transaction.

At expiry, he pays 55 in the futures market and receives the underlying; simultaneouslyhe sells the underlying for 55 in the cash market. These transactions on the expiry daycancel out apart from transaction costs.Consider next an arbitrageur who has sold futures and bought the underlying for a cashand carry arbitrage. Under physical settlement, the arbitrageur simply delivers theunderlying into the futures market.Under cash settlement, the arbitrageur needs to sell the underlying in the cash market at

http://www.futurestradingpedia.com/futures_final_settlement.htmhttp://www.futurestradingpedia.com/futures_final_settlement.htmhttp://www.futurestradingpedia.com/futures_final_settlement.htmhttp://www.futurestradingpedia.com/futures_final_settlement.htm

8/3/2019 Advantages of Call Option

3/4

expiry. The transaction costs here include an execution risk - the risk that the pricerealised in the cash market may not be exactly the same as the settlement price used forcash settlement in the futures market.We now turn to the hedger who owns the underlying and is trying to hedge its value.Assuming that the hedge has been rolled over until the expiry matches the holding

period of the underlying, the hedger's position is identical to that of the arbitrageur.Under cash settlement he needs to sell in the cash market and incur the transactioncosts and execution risks.Finally, we look at the manipulator trying to implement a bear squeeze. Under bothmodes of settlement, the manipulator buys both spot as well as futures.In physical settlement, when he has bought up most of the floating stock, he makes aprofit by selling the underlying to the shorts at an inflated price.The shorts deliver this underlying back to him. In cash settlement, the manipulator gainsby the futures being settled at the inflated price.

The underlying bought in the cash market remains with him. Under both settlementmodes, the manipulator's transactions are the same and his holdings post expiry arealso the same. In both modes, the defence against manipulation is position limits andlarge position disclosure.In short, apart from transaction costs, there is no difference between cash settlementand physical settlement.Even these costs do not apply to most trades because they are squared off beforeexpiry. The choice of settlement mode can, therefore, be safely left to market forces.

But if the regulator chooses to intervene, it should be on the side of physical settlementbecause it imposes lower transaction costs on hedgers and arbitrageurs at the cost ofhigher transaction costs on speculators.One final point about price discovery: under both modes of settlement, arbitrage keepsfutures and cash prices tightly coupled. The principal exception is under intense shortsale restrictions, when the cash price gets decoupled from the true equilibrium price.Cash settlement may allow the futures price to track the true price even in this scenario.When liquid futures and spot markets disagree, usually the futures is right because thereare less friction in the futures market.

8/3/2019 Advantages of Call Option

4/4

contract size

Definition

The quantityof the underlying securitythat the holder of

an optionpossessesthe right to buyor sell. For an equity option,

the contractsize is 100 shares (unless a splitor other specialcircumstances

have occurred).

Open interest

It refers to the total number ofderivative contracts, like futures andoptions, thathave not been settled in the immediately previous time period for aspecific underlyingsecurity. A large open interest indicates more activity andliquidity for the contract.

Volume represents the total amount of trading activity or contracts that have

changed hands in a given commodity market for a singletrading day. The greater the

amount of trading during a market session the higher will be the trading volume. Asmentioned earlier, a higher volume bar on the chart means that the trading activity

was heavier for that day. Another way to look at this, is that the volume represents ameasure of intensity or pressure behind a price trend. The greater the volume the

more we can expect the existing trend to continue rather than reverse. Techniciansbelieve that volume precedes price, meaning that the loss of upside price pressure in

an uptrend or downside pressure in a downtrend will show up in the volume figuresbefore presenting itself as a reversal in trend on the bar chart.

Open Interest is the total number of outstanding contracts that are held

by market participants at the end of each day. Where volume measures the pressureor intensity behind a price trend, open interest measures the flow of money into the

futures market. For each seller of a futures contract there must be a buyer of thatcontract. Thus a seller and a buyer combine to create only one contract. Therefore,

to determine the total open interest for any given market we need only to know thetotals from one side or the other, buyers or sellers, not the sum of both.

http://www.businessdictionary.com/definition/quantity.htmlhttp://www.investorwords.com/5836/underlying_security.htmlhttp://www.investorwords.com/2324/holder.htmlhttp://www.investorwords.com/3477/option.htmlhttp://www.investorwords.com/10660/possess.htmlhttp://www.investorwords.com/12288/right_to_buy.htmlhttp://www.investorwords.com/4467/sell.htmlhttp://www.investorwords.com/1734/equity_option.htmlhttp://www.investorwords.com/1079/contract.htmlhttp://www.investorwords.com/8392/size.htmlhttp://www.investorwords.com/4525/share.htmlhttp://www.investorwords.com/4648/split.htmlhttp://www.investorwords.com/11149/special.htmlhttp://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Underlyinghttp://www.traderji.com/http://www.traderji.com/http://www.businessdictionary.com/definition/quantity.htmlhttp://www.investorwords.com/5836/underlying_security.htmlhttp://www.investorwords.com/2324/holder.htmlhttp://www.investorwords.com/3477/option.htmlhttp://www.investorwords.com/10660/possess.htmlhttp://www.investorwords.com/12288/right_to_buy.htmlhttp://www.investorwords.com/4467/sell.htmlhttp://www.investorwords.com/1734/equity_option.htmlhttp://www.investorwords.com/1079/contract.htmlhttp://www.investorwords.com/8392/size.htmlhttp://www.investorwords.com/4525/share.htmlhttp://www.investorwords.com/4648/split.htmlhttp://www.investorwords.com/11149/special.htmlhttp://en.wikipedia.org/wiki/Derivative_(finance)http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Underlyinghttp://www.traderji.com/http://www.traderji.com/