The Finatical
Week of August 30th, 2021 - Understanding Options Trading, China's Economy Decelerates, Fed Considerers Tapering
FinaticTips - 3 Tips to Understand Options Trading
Several components make up an investor’s portfolio such as bonds, ETFs, stocks etc. An option is just another component. An option is a contract that gives the bearer the right — but not the obligation to — buy or sell an underlying asset at a predetermined price over a specified period of time. Let’s put this into context.
Types of Options
There are two kinds of options:
Call Options - An option that gives the bearer the right to buy an asset
Put Options - An option that gives the bearer the right to sell an asset
Call Options
A call option can simply be thought of as a down payment for a purchase you want to make in the future but you might choose to not make that purchase. So, the sole risk in call options is that you can incur a maximum loss of the initial down payment but that’s it. Let’s consider an example. Suppose you are a businessman and you wish to buy a property to expand your business. The property in its current state does not suit your requirements but future developments in the area can make it worth the money. A call option will ensure that you can purchase that property anytime over a specified period of time, say, two years. The purchase will be at a predetermined price so any increase in the value of the property will not affect your contract whatsoever and that is where the advantage of an option lies. The only risk is that the property still might not suit your business requirements after the expiry of the two year period after which you will no longer be eligible to buy the property at the initial price. The price value of an option is known as the premium and it is nonrefundable.
There is some degree of risk involved in the process but that is also present while managing stocks and bonds. Eventually, right decision making can give you more financial freedom!
Put Options
A put option can be thought of as an insurance policy. Here’s an example: suppose you own a stock worth $2000 that you might want to sell in the future. There is no sure way of knowing how the stock price will fluctuate over a period of time and so there is a chance that the stock might fall down to $1500 by the end of the period. In such circumstances, a put option can come in handy as it will allow you to sell the stock at the predetermined price of $2000. But what if the stock price went up? Well, in such a case, you can always sell the stock at the predetermined price or you can choose to lose the option premium and sell the stock to someone else at the current market price. Here too, the risk involved is quite similar to call options. Basically, option-buying or selling is all about the probability of certain future events that can affect an asset.
Holders and Writers
People who buy options are called holders and those who sell options are called writers of options.
Here is the important distinction between holders and writers:
Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights. This limits the risk of buyers of options to only the premium spent.
Call writers and put writers (sellers), however, are obligated to buy or sell if the option expires in the money (more on that below). This means that a seller may be required to make good on a promise to buy or sell. It also implies that option sellers have exposure to more—and in some cases, unlimited—risks. This means writers can lose much more than the price of the options premium.
Types of options
American Options - It is a version of an options contract that allows holders to exercise the option rights at any time before and including the day of expiration.
European Options - It is a version of an options contract that allows holders to exercise option rights only at the time of expiration of the contract.
Exotic Options - Exotic options are a variation of the American and European style of options. Exotic options are hybrids of American and European options and will often fall somewhere in between these other two styles.
FinaticTrends - 2 Financial Trends
1 - China's Economy Decelerates
New data on retail sales, industrial production, and fixed asset investment in China indicates healthy growth, but at a significantly slower pace than previously and slower than investors had anticipated. Moreover, China’s central bank last week unleashed the equivalent of US$92 billion in medium-term loans to financial institutions to offset an evident slowdown. Many factors are leading to a deceleration of China’s economy such as rising infections, new restrictions on mobility, supply chain bottlenecks, natural disasters, and a decelerating global demand for Chinese-made goods. Eventually the recovery of the Chinese economy will depend on the virus and while China is taking concrete steps to keep the situation under control and to eradicate the Delta variant, it is reported that the Chinese vaccines are less effective than those offered in North America or Europe. Necessary precautions will have to be taken if the country hopes to host the Winter Olympics in early 2022.
2 - Fed Considerers Tapering
Since the pandemic began, the Federal Reserve has engaged in massive monthly asset purchases meant to suppress bond yields and, therefore, keep credit markets functioning during the crisis. The Fed has previously signaled that this policy will be sustained until the Fed’s goal of stable inflation and maximum employment is met. Lately, given the sudden surge in inflation, the decline in unemployment, and the existence of a labor shortage, many Fed leaders have started to discuss the possibility of reducing or ending the asset purchase program. Last week, the Fed released the minutes of the last meeting of the Federal Open Market Committee (FOMC), the principal policy making body of the Fed. The minutes indicate that most FOMC members now favor tapering asset purchases later this year, while some want to wait until next year. Even though the Fed has been signalling this decision for a while, the release of the minutes must have come as a surprise to investors as equity prices and bond yields fell this week. In any event, growing concern about the Delta variant is also affecting markets, making it difficult to identify the impact of the Fed announcement.
Financial Guidance
“A budget is more than just a series of numbers on a page; it is an embodiment of our values.” ― Barack Obama
Money Fact
The vast majority of the planet's currency exists in electronic form – banknotes and coins make up just 8% of the global total.
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