When it comes to online trading, there's not just Forex and Binary Options, of course. Sure, these are the activities that are most popular, but only because the advertising pressure exerted on their behalf by brokers is more intense. There are a myriad of other instruments capable of satisfying investors' needs, both in a speculative sense and for mere capital protection. One instrument that, from this point of view, is versatile and balanced is represented by
Vanilla Options. These are ideal for both those who want to speculate and those who simply want to protect their capital.
The term "options" can be misleading, and it certainly has been for less experienced traders who have approached this instrument thinking it was a variant of binary options. In reality, "binary" and "vanilla" are two (almost) completely different worlds. Just think that binary options are considered by some to be little more than gambling, given their incredibly similar mechanism to betting. Conversely, Vanilla Options, in addition to enjoying transversal respect and authority, are used by entrepreneurs, small or large, to protect their investments and production activities from price fluctuations, as well as - obviously - by retail traders to increase a starting capital, a bit like what is done with Forex.
Yet, even compared to Forex, they are quite another thing. Not only in terms of mechanisms, which is obvious given that each trading activity has its own specificity, but also in terms of approach, underlying philosophy, and dynamics. The reason? Always the same: Vanilla Options are like coins and have two faces, one winking at speculative investors and the other at those who simply want to protect their capital. To be clear, Forex also lends itself to a double use, so much so that it is frequented by some subjects to defend themselves against exchange rate risk, but this is an elitist use, reserved for multinationals (operating in countries with different currencies).
What are Vanilla Options
Returning to Vanilla Options, let's try to give the most concise definition possible. Vanilla Options are trading instruments through which a subject is granted
the right to buy, or sell, a given asset, by a specific date at a predetermined price.
From this point of view, Vanilla Options may resemble futures, but there are differences and they are important. First, we are talking about a right, not an obligation. Futures impose the realization of the transaction when the X hour strikes, Vanilla Options do not. In fact, we are talking about an "option", which in Italian as in English is synonymous with alternative. Moreover, those who hold a Vanilla Option can not only avoid exercising this right - simply by letting the option expire - but also exercise it before expiration. The important thing is to do it
before the expiration.
Furthermore, and this is probably the most important difference, Vanilla Options impose the payment of a
premium. Yes, those who have the right to exercise the purchase must pay a premium, which is a sum that does not depend on price fluctuations but on a whole series of factors. The premium, to be clear, is the "price" that compensates for the
possibility of exercising the option, and is therefore exerted by the margin of discretion reserved for those who have subscribed to the option. It is no coincidence that the premium is an element completely extraneous to Futures, where this margin of discretion does not exist. The existence of the premium, and together with the optionality inherent in the mechanism of Vanilla Options, makes the latter a valid instrument especially
for those who want to protect their capital. Why? Where does this need come from? And how do Vanilla Options satisfy it?
Let's make a very practical example, which does not concern speculation and does not involve the dynamics - certainly complex to an inexperienced eye - of traders as we understand them today. Let's hypothesize, rather, a coffee producer, who has to buy the raw material, i.e. coffee beans, from a supplier. Now, let's suppose that at the present moment coffee beans cost 100 euros per ton. Too bad the market is very volatile, with a worrying upward trend and that the unfortunate producer does not need the raw material today, but in three months. What to do? Buy the coffee when it is needed? No, if there is a fear that the price may increase. The solution is represented precisely by Vanilla Options, which allow the producer himself to protect himself from volatility. In this case, he will enter into an option that will allow him within three months to purchase the coveted ton of coffee beans at the current price, at the time of signing: 100 euros. Obviously, there is a premium to pay, which will realistically be 10 euros. Here, with those 10 euros he has purchased, so to speak, security. If the prediction turns out to be correct, the coffee three months later will have increased by 15 euros, reaching a cost of 115 euros. The producer, despite the premium, will have saved 5 euros.
Now, from this example it is clear that there are two elements that determine the success of an operation that has Vanilla Options as its protagonist: the forecasting ability and the evaluation of the premium.
The importance of
forecasting ability is practically didactic. The producer in the example gained because he predicted that the price of coffee would rise, and quite a bit. If he had not had forecasting skills on his side, he would have conducted the deal differently and lost out. Of course, by forecasting ability we do not mean some mystical divination skill, but the banal - when technical and fundamental - ability to study the market and draw bullish and bearish signals. In short, nothing different from the technical and fundamental analysis that all traders practice.
When we talk about
premium, the discussion becomes more complicated. Deciding on a premium - which is still the result of a negotiation - is never easy. Also because there are numerous factors to consider, and there are many elements that contribute to raising or lowering it.
One of the simplest factors to understand is the current price of the asset. It's obvious, the premium, even if not expressed as a percentage, still has a link with the price. The 10 euros of premium on 100 euros of coffee have a weight, but the same 10 euros on a price of 10,000 have a very different weight.
The expiration date also influences, and for an easily intuitable reason: the farther away the expiration, the greater the uncertainty, the riskier the entire operation. It follows that the time factor is directly proportional to the premium. If the expiration moves away, the premium rises.
For the same reason, therefore linked to uncertainty, another factor of sure weight is
volatility. This generates uncertainty, therefore it makes the premium skyrocket. The fact is that Vanilla Options offer important security guarantees to the buyer, and this is a service that, in these cases, comes at a high price.
The technical terms of Vanilla Options
So far, Vanilla Options in a nutshell. But it is evident that a superficial knowledge is not enough, if you want to be successful in this field or generate profits worthy of the name. It is necessary, first of all, to enter the way of thinking and above all of speaking of Vanilla Options investors. In plain words, learn the technical jargon. Here are some fundamental and extremely recurring terms.
Underlying. It is the asset object of the transaction. To be clear, indirect object, since when you buy an option you acquire the right to exercise the transaction, not the object itself of the transaction. In the previous example, the underlying is coffee.
Call Options. With this name we identify the options that guarantee the right to purchase the underlying. In the previous example, the producer had, in fact, purchased a call option.
Put Options. With this name we identify the options that, on the other hand, guarantee the right to sell an asset. Within the expiration, the option holder can decide to exercise the option and sell the asset.
Strike Price or Target Price. It is the price at which the eventual transaction will take place (the right, as such, provides for optionality). In the case of the previous example, the strike price is 100 euros.
Spot Price. It is the price at the time of signing, which may be different from the strike price (it certainly is, if the market is not in a solid lateral phase). In the case of the previous example, spot price and target price (strike price) coincide.
Vanilla Options for speculative purposes
The example we presented a few paragraphs ago has as its protagonist a "conservative" use of Vanilla Options, that is, aimed at protecting a productive activity, an investment, etc. The purpose of the person who bought the options was to defend himself against the price variations that, according to him, would have occurred from then until the time of purchase.
As we explained at the beginning of the article, however, Vanilla Options are
also a speculative instrument, and it is certainly this side of the coin that interests the trader, since there are fewer and fewer entrepreneurs today.
How are Vanilla Options used in a speculative sense? To explain it, it's good to give an example.
Let's hypothesize that the spot price of the euro-dollar pair is 1.1000. The trader predicts that the pair will increase in price within a week. Among the things he could do is buy a call option. The expiration of this option should obviously be one week, the strike price 1.020. If he buys the option, he obviously has to pay a premium, which we imagine could be 50 pips, corresponding to 0.005 euros. If the price at expiration really exceeds the strike price
plus the premium, then the trader can consider the operation a winner. Let's assume the price at expiration is 1.025. In this case, he will break even and will have neither gained nor lost anything. If the price is, for example, 1.030, he will have gained 5 pips.
The advantages of Vanilla Options
After having thoroughly explored the topic, it is possible to take stock of the many advantages associated with the use of Vanilla Options. Here is a quick recap.
Safe investment. First of all, Vanilla Options are a protection tool. But security is also granted to speculative traders. Vanilla, in fact, compared to Forex and especially binary options, are instruments that expose those who use them to lower risks. This is demonstrated by the premium mechanism, which secures, and in a certain sense compensates, even those who make a wrong prediction and, perhaps, have sold an option rather than buying it.
Variety of strategies. This is a typical element, markedly characterizing Vanilla Options. Thanks to these, the trader can express any "point of view" or approach. The trader, in fact, regardless of the "direction" of the option (call or put) can always find a safe position to be comfortable, and then there is the premium, if necessary, to act as a parachute.
Possibility to go against the market. For the same reason, trading with Vanilla Options is one of the few that allows you to go against the market without taking on the risks, for example, typical of Scalping.
Vanilla Options with AvaTrade
To trade with Vanilla Options, obviously, you need a broker. If possible, a market mover, so that the execution of your orders is always guaranteed. Among the best brokers around, and among the few that offer trading with Vanilla Options,
AvaTrade stands out.
One of the merits of this broker, in addition to the breadth of the offer, the low costs and the excellent performance, is represented by the educational content. Avatrade cares about its customers, even aspiring ones, therefore it sets up a real educational center through which the uninitiated can learn the art of trading. A huge competitive advantage, considering that Vanilla Options are instruments still little known by the great mass, and in any case less intuitive than Forex and binary options.
AvaTrade focuses a lot on Vanilla Options, to the point of providing an ad hoc platform:
AvaOptions. Vanilla Options traders can therefore take advantage of a specialized offer, suitable for their needs and able to create all the conditions for a lasting and profitable trading activity. The platform, by the way, is equipped with an accessible interface, which further optimizes and facilitates the work of traders. It is no coincidence that AvaTrade has become the reference point for those who practice this particular type of trading.
