Sunday, August 26, 2007

The Art of Futures and Options Trading

Options on currencies, Treasury bills, notes and bonds, stocks and bonds indexes, and futures contracts are currently being traded. Since they are derivatives of actual investments, they can be difficult for individuals to understand and use profitably. The fact is that options traders loose money 60% of the time. These types of options are appealing to traders that want to protect their investments against major swings in market prices, or speculate on the markets movements.

Buying put options on stock indexes is a way for investors to hedge their portfolios against sharp drops in the market. It gives them the right to sell their option and make a profit if the market falls. the money realized on a sale will hopefully cover the losses in their portfolios resulting from the falling market. In order for this technique to work, the options have to be on the index that most closely tracks the kind of stocks they own. Plus there has to be enough options to offset the total value of the portfolio. Because options cost money and they expire quickly, using this kind of insurance regularly can take a big bite out of any of the profits that the portfolio itself produces.

Speculators use index options to gamble on shifts in the market direction. like other methods of high risk investing, this one offers the chance of making a big killing if the investor gets it right. Otherwise there wouldn't be any takers. However the risks of getting the price and the time right are magnified by the short life span of the index options. A complicated factor is that indexes don't always move in the same direction as the markets they track. When indexes are out of kilter, there are big profits to be made by the arbitrage traders with computer programs that are fine-tuned enough to take advantage of the movements.

Options are traded through options trading firms on the futures exchanges on the Chicago Board Options Exchange, and on four other stock exchanges. like futures contracts, options contracts are traded exclusively on the exchange that makes, or originates, them. Trades are handled through the exchanges where they take place. buy and sell orders are matched anonymously, and can be canceled by using an offsetting contract.

The SEC has initiated a controversial program with stock options, they are allowing them to be listed, and made available for sale on all of the exchanges the way that stocks themselves are. Currently, the Chicago and American exchanges, which trade contracts in blue-chip stocks, controls more than 75% of the business, with Philadelphia and Pacific exchanges about 22%. One change that multiple listing means is a shift to the increased use of telephone and computer-generated trading, introducing opportunities for comparison shopping and for arbitrage.

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