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Every journey begins with a first step and for your new trading strategy that step should be a comprehensive review of the basics of options. even though it may be elementary for most traders, understanding the structure of options and their function in trading is essential to each section that follows.An options contract is the right, but not the obligation, to buy or sell the underlying futures contract at a particular price - the option's "strike price". in the case of a call option this is a right to buy the underlying futures at the strike price. For a put option, it is the right to sell the underlying futures at the strike price. in either case, the option is bought or sold for a price known as "premium". For the buyer of options, premium represents the amount they will risk on a particular position. these buyers might be people who are hedging an actual cash position or, more likely, speculators with a strong directional view. For a speculator who has a bullish view on a market, a call option offers a risk defined opportunity to play this view. this defined risk position is part of the universal appeal of options. unlike a straight futures position which offers unlimited risk, the most the option buyer is putting on the table is the amount they paid for the option. they are paying the price for a chance that the futures will move in the direction they want it to.This position is a finite one. every option has an expiration date and the clock is always ticking. the buyer of an option has everything to lose with this passage of time. if his directional view of the market is correct, the movement of the underlying futures will have to be large enough to create intrinsic value in the option, which is to say, the futures must move beyond the strike price of the option, and it must happen on or before the expiration date.Enter the option seller, the proverbial house in this equation. For every option buyer who wants the market to move in a particular fashion, there is the seller who collects premium and profits when the market fails to move past the strike price of the option before expiration. the underlying futures can move in the opposite direction, trade sideways or even wait to move towards the strike price of the option until time has eroded the value so effectively as to leave the seller with some - if not all - of the premium originally collected. the exchange for this unique position of favored odds is an unlimited amount of risk with a definite amount of profit. While some option sellers are establishing an offset for a long option, others collect premium against a futures contract or physical position. house Odds will focus, however, on premium collection as an independent trading approach.As with any new venture, delving further into the world of commodity options to begin working with premium collection strategies will expose you to new vocabulary. in the case of options, the most obvious new words have their origins in the Greek language - delta, gamma, theta, and vega. the Greeks, as they are often called, are measures of risk. each of the four terms represents a rate of change calculation or statistic for the option and can be beneficial in determining how the price of an option will change with particular market variables.When applied to option trading strategies, this collection of concepts can help you calculate your risk and also help you determine when there is an opportunity to enter into a short option position.Delta is a term that may be familiar to most traders and is the most commonly referenced when applied to options. in its most basic definition, delta is the measure of an option's price change in relation to the change in the underlying futures contract. For example, if the futures contract changes by a full point (1.00) and the option price changes by half a point (.50) then the option has a delta of 50%. in the case of a call option with a 50% delta, a one point price increase in the futures contract would result in a half point increase in the price of the option. For many traders, the delta of an option is an expression of probability that the option will trade in-the-money.
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