Options trading is a popular way to speculate on the direction of Hong Kong stocks, but it can be complex and risky. The article looks at what beginners need to know about how options work before they start trading.
What is options trading?
An option is a type of trading contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a set price within a specific period. Options are often used as hedges against other investments or as speculative bets on the direction of an underlying stock.
There are two types of options contracts available to traders in Hong Kong:
- Put options: It allows you to sell an underlying asset at a set price.
- Call options: It allows you to buy an underlying asset at a set price.
Where are options traded?
Options are traded on the Hong Kong Stock Exchange (HKEX), with most options expiring on the third Friday of each month.
The critical parameters of an option contract
The critical parameters of an option contract are the underlying asset, the strike price, the expiration date, and the premium.
The underlying asset in the contract can be a stock, a commodity, an index, or a currency. For example, the Hang Seng Index (HSI) is often used as the underlying asset for options traded on HKEX.
The strike price is when the option holder can buy or sell the underlying asset. The expiration date is when the option contract expires and becomes void. The premium is the option contract’s price and is paid by the holder to the seller when the contract is bought.
Pricing of options
Options are priced based on several factors, including the price of the underlying asset, the strike price, the expiration date, and the underlying asset’s volatility.
The price of the underlying asset
The underlying asset price is the most crucial factor in determining the price of an option. The higher the underlying asset price, the more expensive the option will be.
The strike price
The strike price is also a significant factor in determining the price of an option. The closer the strike price is to the current market price of the underlying asset, the more expensive the option will be.
The expiration date
The expiration date is another crucial factor in determining the price of an option. The closer the expiration date is to the current date, the more expensive the option will be.
Benefits of trading options in Hong Kong
There are several benefits to trading options in Hong Kong. Options allow traders in Hong Kong to speculate on the direction of an underlying asset without taking ownership of the asset, meaning that traders can use options to hedge other positions or make speculative bets on the direction of an underlying stock.
Risks of options trading
Options are complex financial instruments and can be very risky. Beginners should only trade options with money they can afford to lose. There are two main types of risks associated with options trading: market risk and credit risk.
Market risk is the risk that the underlying asset’s price will move against the position taken by the trader. For example, if a trader in Hong Kong buys a call option on a stock, they are speculating that the stock will rise in price, and if the stock falls, the trader will lose money.
Credit risk is a trading risk that the counterparty to the trade will not be able to meet their obligations, and this can happen if the counterparty is unable to pay the premium or if they are unable to deliver the underlying asset when the option is exercised.
Options trading is a complex and risky financial activity. Beginners should only trade options with money they can afford to lose and should always be aware of risks. Novice traders should use a reputable and experienced online broker such as Saxo Markets before trading options; look at this site for more information.