With news breaking that Saudi Arabia will soon introduce options trading on single stocks, it is an exciting time to learn more about stock options and how it works. The reason for this introduction is because the country is looking to boost liquidity in its stock market, which is currently the biggest financial market in the Middle East.
What are stock options?
Stock options are a type of financial contract that gives the holder of the contract the right, but not the obligation, to buy or sell a set number of st犀利士
ocks at a specified price on or before a specified date.
There are two main types of stock options: calls and puts.
Call options allow the contract holder to buy the stock at a specified price within a specific timeframe, while put options allow the contract holder to sell the stock at a specified price within a specific timeframe.
Some important terminology in stock options trading
For traders new to options trading, they may come across some confusing terminology that they have never seen before in other investment products. Below, we will explain them:
The expiration date of a contract is the date that the contract has to be exercised. This can be chosen by the person who buys the contract.
The strike price is the price that determines whether an option should be exercised. This is the price that the trader has anticipated a stock will reach by or before the expiration date. If the trader is correct, then the trade is a success.
The contract size is the number of underlying shares that a trader is looking to buy when they purchase a stock options contract. One contract is equal to 100 shares of the underlying stock. This means that if a trader decides to buy 3 contracts, they will be buying 300 shares of the underlying stock.
The premium is the price paid for the options contract. This is determined by the price of the call, and it is multiplied by 100 and the number of contracts bought.
Why are stock options popular amongst traders?
Stock options have long been popular investment amongst traders around the world for a myriad of reasons. Below are four main ones:
Options are leveraged products
Stock options can increase the cost-efficiency of each trade. As a leveraged product, traders can open a bigger position with the small amount of principal. Leverage is presented in ratios, such as 1:100.
Let’s say a trader wants to purchase a stock from ABC Corporation. The stock is priced at $200 per share. A trader purchases an options contract to trade it instead and is able to use a leverage of 1:50. In this case, the trader puts down only $200 to open a position of $200 * 50 = $10,000. This effectively enables him to open a position that is worth 50 shares.
Suppose the stock market moves in his favour, and the share price of ABC Corporation increases by $5 per share. As profits are calculated against the full position size, the trader finds that he has made a profit of $5 * 50 = $250. Compared to his initial investment of $200, he has made a huge profit of 125%.
If he has never used leverage and the share price increases by $5, he would have made a profit of $5 * 1 = $5, which is a miniscule 2.5% profit.
Traders can buy or sell with options
Another advantage of stock options is that traders can take either long or short positions when they purchase a contract, expressed in terms of call and put options. This gives them the ability to potentially profit from both bullish and bearish markets.
Options give traders the right, but not the obligation, to buy or sell
Options trading is often confused with futures trading, as both types of transactions involve a contract and a future settlement date. The difference between options and futures contracts, however, is that options are not legally binding. While futures contracts holders must exercise the contract on or before its expiration date, options contracts give holders the right but not the obligation to exercise it.
A stock options trader who holds a contract can lock in the price of a stock early on, following their predictions on which way the markets will move. Simultaneously, they can continue to look in the open market for stock valuations.
If they find that on the expiration date that share prices are better in the open market, they can choose to abandon the contract. Once an options contract expires, they are considered worthless, and the trader will only have ‘wasted’ money on the premium paid to purchase the contract.
How to start trading stock options
Trading stock options is relatively easy and convenient for local traders. For those who want to get in on the action right away, you can open an account with a reputable and trustworthy broker such as Saxo Bank.
After opening an account, you can verify your bank and personal details. When your application is accepted, you can begin depositing funds into your account and start trading.
If you are a novice trader who would like to take some time to hone your skills in trading stock options, you can always start trading on a demo account first. Demo accounts imitate live trading conditions on your preferred platform without risking any of your real capital. This can be extremely useful for traders who would prefer to gain experience after reading sufficient theory.
This is an exciting time for stock traders in Saudi Arabia, and the country’s plans to boost the market’s liquidity does not end here. There are also talks of liberalising the Riyadh’s stock exchange to encourage foreign investors’ participation in the future, with the bourse to begin registering more stocks upon meeting certain criteria. This is something expats in the country should certainly keep an eye on.