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Unlike the stock market, futures positions are settled on a daily basis, which means that gains and losses from a day's trading are deducted or credited to a person's account each day. Teaching Financial Literacy To Tweens. Investors use options both to speculate and hedge risk. If you already have E-Trade Financial Broker Summary:

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Since we do not typically start out with four mallets in our hands as percussion- ists, there is a great MS Excel is capable of making calculations automatically once the cells have been properly programmed. This feature can be used to make a single Since this Basics ebook is free, you can print a copy for your own use, and feel free to share the This tutorial will introduce you to the fundamentals of options. There are four types of participants in options markets depending on the position.

Options Basics Tutorial http: As always, we welcome any feedback or suggestions. Introduction 2 Options Basics: How Options Work 5 Options Basics: Conclusion 1 Introduction Nowadays, many investors' portfolios include investments such as mutual funds, stocks and bonds. But the variety of securities you have at your disposal does not end there.

Another type of security, called an option, presents a world of opportunity to sophisticated investors. The power of options lies in their versatility. They enable you to adapt or adjust your position according to any situation that arises. Options can be as speculative or as conservative as you want. This means you can do everything from protecting a position from a decline to outright betting on the movement of a market or index.

This versatility, however, does not come without its costs. Options are complex securities and can be extremely risky.

This is why, when trading options, you'll see a disclaimer like the following: Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital. Despite what anybody tells you, option trading involves risk, especially if you don't know what you are doing.

On the other hand, being ignorant of any type of investment places you in a weak position. Perhaps the speculative nature of options doesn't fit your style. No problem - then don't speculate in options. But, before you decide not to invest in options, you should understand them. Not learning how options function is as dangerous as jumping right in: Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another.

Keep in mind that most options traders have many years of experience, so don't expect to be an expert immediately after reading this tutorial. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties. The idea behind an option is present in many everyday situations.

Say, for example, that you discover a house that you'd love to purchase. Unfortunately, you won't have the cash to buy it for another three months. Now, consider two theoretical situations that might arise: It's discovered that the house is actually the true birthplace of Elvis! While touring the house, you discover not only that the walls are chock-full of asbestos, but also that the ghost of Henry VII haunts the master bedroom; furthermore, a family of super-intelligent rats have built a fortress in the basement.

Though you originally thought you had found the house of your dreams, you now consider it worthless. On the upside, because you bought an option, you are under no obligation to go through with the sale. This tutorial can be found at: This example demonstrates two very important points. First, when you buy an option, you have a right but not an obligation to do something.

You can always let the expiration date go by, at which point the option becomes worthless. Second, an option is merely a contract that deals with an underlying asset. For this reason, options are called derivatives, which means an option derives its value from something else. In our example, the house is the underlying asset. Most of the time, the underlying asset is a stock or an index. Calls and Puts The two types of options are calls and puts: A call gives the holder the right to buy an asset at a certain price within a specific period of time.

Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires. A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

Participants in the Options Market There are four types of participants in options markets depending on the position they take: Buyers of calls 2.

Sellers of calls 3. Buyers of puts 4. Sellers of puts People who buy options are called holders and those who sell options are called writers; furthermore, buyers are said to have long positions, and sellers are said to have short positions. Here is the important distinction between buyers and sellers: They have the choice to exercise their rights if they choose. This means that a seller may be required to make good on a promise to buy or sell.

Don't worry if this seems confusing - it is. For this reason we are going to look at options from the point of view of the buyer. Selling options is more complicated and can be even riskier.

At this point, it is sufficient to understand that there are two sides of an options contract. The Lingo To trade options, you'll have to know the terminology associated with the options market. The price at which an underlying stock can be purchased or sold is called the strike price.

This is the price a stock price must go above for calls or go below for puts before a position can be exercised for a profit. All of this must occur before the expiration date. These have fixed strike prices and expiration dates. Each listed option represents shares of company stock known as a contract. For call options, the option is said to be in-the-money if the share price is above the strike price.

A put option is in-the-money when the share price is below the strike price. The amount by which an option is in-the-money is referred to as intrinsic value. The total cost the price of an option is called the premium. This price is determined by factors including the stock price, strike price, time remaining until expiration time value and volatility.

Because of all these factors, determining the premium of an option is complicated and beyond the scope of this tutorial 3 Why Use Options? There are two main reasons why an investor would use options: Speculation You can think of speculation as betting on the movement of a security. The advantage of options is that you aren't limited to making a profit only when the market goes up.

Because of the versatility of options, you can also make money when the market goes down or even sideways. Speculation is the territory in which the big money is made - and lost.

The use of options in this manner is the reason options have the reputation of being risky. This is because when you buy an option, you have to be correct in determining not only the direction of the stock's movement, but also the magnitude and the timing of this movement.

To succeed, you must correctly predict whether a stock will go up or down, and you have to be right about how much the price will change as well as the time frame it will take for all this to happen.

And don't forget commissions! The combinations of these factors means the odds are This tutorial can be found at: So why do people speculate with options if the odds are so skewed? Aside from versatility, it's all about using leverage. When you are controlling shares with one contract, it doesn't take much of a price movement to generate substantial profits.

Hedging The other function of options is hedging. Think of this as an insurance policy. Just as you insure your house or car, options can be used to insure your investments against a downturn. Critics of options say that if you are so unsure of your stock pick that you need a hedge, you shouldn't make the investment. On the other hand, there is no doubt that hedging strategies can be useful, especially for large institutions. Even the individual investor can benefit. Imagine that you wanted to take advantage of technology stocks and their upside, but say you also wanted to limit any losses.

By using options, you would be able to restrict your downside while enjoying the full upside in a cost-effective way. A Word on Stock Options Although employee stock options aren't available to everyone, this type of option could, in a way, be classified as a third reason for using options. Many companies use stock options as a way to attract and to keep talented employees, especially management.

They are similar to regular stock options in that the holder has the right but not the obligation to purchase company stock. The contract, however, is between the holder and the company, whereas a normal option is a contract between two parties that are completely unrelated to the company. We'll use a fictional firm called Cory's Tequila Company.

Let's say that on May 1, the stock price of Cory's Tequila Co. In reality, you'd also have to take commissions into account, but we'll ignore them for this example. Remember, a stock option contract is the option to buy shares; that's why you must multiply the contract by to get the total price.

You almost doubled our money in just three weeks! You could sell your options, which is called "closing your position," and take your profits - unless, of course, you think the stock price will continue to rise. For the sake of this example, let's say we let it ride. To recap, here is what happened to our option investment: This is leverage in action. Exercising Versus Trading-Out So far we've talked about options as the right to buy or sell exercise the underlying.

This is true, but in reality, a majority of options are not actually exercised. You could also keep the stock, knowing you were able to buy it at a discount to the present value. However, the majority of the time holders choose to take their profits by trading out closing out their position.

This means that holders sell their options in the This tutorial can be found at: Intrinsic Value and Time Value At this point it is worth explaining more about the pricing of options.

These fluctuations can be explained by intrinsic value and time value. Remember, intrinsic value is the amount in-the-money, which, for a call option, means that the price of the stock equals the strike price. Time value represents the possibility of the option increasing in value. So, the price of the option in our example can be thought of as the following: If you are wondering, we just picked the numbers for this example out of the air to demonstrate how options work.

Types Of Options There are two main types of options: The example about Cory's Tequila Co. Page 1 of Behavioral Finance - Investopedia 6 Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias Behavioral finance is a relatively new field that seeks to combine behavioral and.

Maple Financial Group Professor of Rotman School of Management. Video presentations of selected tutorials and exercises. Prepares you for the Autodesk. Tutorial - First Level: If you want to use a hard copy version of this tutorial, then download the PDF This is an instructional tutorial dealing with the fundamentals of Time of Flight technology.

It is divided into three parts dealing with:. Many people wonder how The focus of this book is simple financial derivatives—options and futures. The growth of these instruments began Advanced Financial Statements Analysis - Investopedia advanced overview of financial statements analysis. If you already have Guide to Stock-Picking Strategies - Investopedia stock picking - selecting stocks based on a certain set of criteria, with the aim of achieving a The bottom line is that there is no one way to pick stocks.

The NFA ensures that authorized forex dealers are subject to stringent screening upon registration and Fundamentals of 3D imaging and displays: This broad interest is evidenced Oregon Institute of Technology.

A video presentation of selected tutorials. Futures options expire worthless. Most of the time, Gaston Berger, who coined the term prospective. How The Market Works. Futures Fundamentals Tutorial http: As always, we welcome any feedback or suggestions. Introduction 2 Futures Fundamentals: A Brief History 3 Futures Fundamentals: The Players 5 Futures Fundamentals: Characteristics 6 Futures Fundamentals: Strategies 7 Futures Fundamentals: How To Trade 8 Futures Fundamentals: Conclusion Introduction What we know as the futures market of today came from some humble beginnings.

Trading in futures originated in Japan during the 18th century and was primarily used for the trading of rice and silk. It wasn't until the s that the U. A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price.

If you buy a futures contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. That is why futures are used as financial instruments by not only producers and consumers but also speculators. The futures market is extremely liquid, risky and complex by nature, but it can be understood if we break down how it functions. While futures are not for the risk-averse, they are useful for a wide range of people. In this tutorial, you'll learn how the futures market works, who uses futures and which strategies will make you a successful trader on the futures market.

A Brief History Before the North American futures market originated some years ago, farmers would grow their crops and then bring them to market in the hope of selling their inventory. But without any indication of demand, supply often exceeded what was needed and unpurchased crops were left to rot in the streets!

Conversely, when a given commodity - wheat, for instance - was out of season, the goods made from it became very expensive because the crop was no longer available. In the midth century, central grain markets were established and a central marketplace was created for farmers to bring their commodities and sell them either for immediate delivery spot trading or for forward delivery.

The latter contracts - forward contracts - were the forerunners to today's futures contracts. In fact, this concept saved many a farmer the loss of crops and profits and helped stabilize supply and prices in the off-season. Today's futures market is a global marketplace for not only agricultural goods, but also for currencies and financial instruments such as Treasury bonds and securities securities futures. It's a diverse meeting place of farmers, exporters, importers, manufacturers and speculators.

Thanks to modern technology, commodities prices are seen throughout the world, so a Kansas farmer can match a bid from a buyer in Europe.

How the Market Works The futures market is a centralized marketplace for buyers and sellers from around the world who meet and enter into futures contracts. Pricing can be based on an open cry system, or bids and offers can be matched electronically. The futures contract will state the price that will be paid and the date of delivery.

But don't worry, as we mentioned earlier, almost all futures contracts end without the actual physical delivery of the commodity. This tutorial can be found at: What Exactly Is a Futures Contract? Let's say, for example, that you decide to subscribe to cable TV.

As the buyer, you enter into an agreement with the cable company to receive a specific number of cable channels at a certain price every month for the next year. This contract made with the cable company is similar to a futures contract, in that you have agreed to receive a product at a future date, with the price and terms for delivery already set. You have secured your price for now and the next year - even if the price of cable rises during that time. By entering into this agreement with the cable company, you have reduced your risk of higher prices.

That's how the futures market works. Except instead of a cable TV provider, a producer of wheat may be trying to secure a selling price for next season's crop, while a bread maker may be trying to secure a buying price to determine how much bread can be made and at what profit. By entering into this futures contract, the farmer and the bread maker secure a price that both parties believe will be a fair price in June. It is this contract - and not the grain per se - that can then be bought and sold in the futures market.

So, a futures contract is an agreement between two parties: In the above scenario, the farmer would be the holder of the short position agreeing to sell while the bread maker would be the holder of the long agreeing to buy.

We will talk more about the outlooks of the long and short positions in the section on strategies, but for now it's important to know that every contract involves both positions. In every futures contract, everything is specified: Profit And Loss - Cash Settlement The profits and losses of a futures contract depend on the daily movements of the market for that contract and are calculated on a daily basis.

As the market moves every day, these kinds of adjustments are made accordingly. Unlike the stock market, futures positions are settled on a daily basis, which means that gains and losses from a day's trading are deducted or credited to a person's account each day. In the stock market, the capital gains or losses from movements in price aren't realized until the investor decides to sell the stock or cover his or her short position. As the accounts of the parties in futures contracts are adjusted every day, most transactions in the futures market are settled in cash, and the actual physical commodity is bought or sold in the cash market.

Prices in the cash and futures market tend to move parallel to one another, and when a futures contract expires, the prices merge into one price. So on the date either party decides to close out their futures position, the contract will be settled. In other words, the farmer's loss in the futures contract is offset by the higher selling price in the cash market - this is referred to as hedging. Now that you see that a futures contract is really more like a financial position, you can also see that the two parties in the wheat futures contract discussed above could be two speculators rather than a farmer and a bread maker.

In other words, neither would have to go to the cash market to buy or sell the commodity after the contract expires. Economic Importance of the Futures Market Because the futures market is both highly active and central to the global marketplace, it's a good source for vital market information and sentiment indicators. Price Discovery - Due to its highly competitive nature, the futures market has become an important economic tool to determine prices based on today's and tomorrow's estimated amount of supply and demand.

Futures market prices depend on a continuous flow of information from around the world and thus require a high amount of transparency. Factors such as weather, war, debt default, refugee displacement, land reclamation and deforestation can all have a major effect on supply and demand and, as a result, the present and future price of a commodity. This kind of information and the way people absorb it constantly changes the price of a commodity.

This process is known as price discovery. Risk Reduction - Futures markets are also a place for people to reduce risk when making purchases. Risks are reduced because the price is pre-set, therefore letting participants know how much they will need to buy or sell. This helps reduce the ultimate cost to the retail buyer because with less risk there is less of a chance that manufacturers will jack up prices to make up for profit losses in the cash market.

The Players The players in the futures market fall into two categories: Hedgers Farmers, manufacturers, importers and exporters can all be hedgers. A hedger buys or sells in the futures market to secure the future price of a commodity intended to be sold at a later date in the cash market. This helps protect against price risks. The holders of the long position in futures contracts the buyers of the commodity , are trying to secure as low a price as possible.

The short holders of the contract the sellers of the commodity will want to secure as high a price as possible. The futures contract, however, provides a definite price certainty for both parties, which reduces the risks associated with price volatility. Hedging by means of futures contracts can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold.

A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already This tutorial can be found at: But what if the price of silver goes up over the next six months? Because the prices of the earrings and bracelets are already set, the extra cost of the silver can't be passed on to the retail buyer, meaning it would be passed on to the silversmith. The silversmith needs to hedge, or minimize her risk against a possible price increase in silver.

Had the price of silver declined in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very volatile, the silver maker was still sheltering himself from risk by entering into the futures contract.

So that's basically what hedging is: Someone going long in a securities future contract now can hedge against rising equity prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price.

The opposite could happen as well: A potato farmer would hedge against lower French fry prices, while a fast food chain would hedge against higher potato prices. A company in need of a loan in six months could hedge against rising interest rates in the future, while a coffee beanery could hedge against rising coffee bean prices next year. Speculators Other market participants, however, do not aim to minimize risk but rather to benefit from the inherently risky nature of the futures market.

These are the speculators, and they aim to profit from the very price change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter what they're investing in, while speculators want to increase their risk and This tutorial can be found at: In the futures market, a speculator buying a contract low in order to sell high in the future would most likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in the future.

Unlike the hedger, the speculator does not actually seek to own the commodity in question.





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