Vanilla Option is a contract that gives the right, but not the obligation, to buy or sell the underlying asset at a certain price on a specified expiration date. The history of the use of Vanilla Option dates back to the 17th century in Europe, where the first stock exchanges opened and options trading became popular. In this article, we will take a closer look at vanilla options, including the basic concept, influencing factors, benefits and risks and examples of their use.
The Basic Concept of Vanilla Option
Vanilla Option is a simple and common option built on top of an underlying asset which can be a stock, commodity, currency or index. There are two types of vanilla options, namely call options and put options. A call option gives the right to buy the underlying asset at a certain price on the expiration date, while a put option gives the right to sell the underlying asset at a certain price on the expiration date. The Vanilla Option mechanism involves buyers and sellers entering into contracts with certain conditions, such as the price of the underlying asset, expiration date, and the amount of the underlying asset being traded.
Factors influencing Vanilla Option
1. The price of the underlying asset is the main factor that influences the value of the Vanilla Option.
2. Market volatility is also very important, because the greater the market volatility, the greater the opportunity for profit and risk.
3. Expiration dates also affect the price of Vanilla Options, because the longer the time available, the greater the opportunity for profit and risk.
4. The interest rate also affects the value of the Vanilla Option, because the higher the interest rate, the more expensive it will be to purchase the option.
There are 3 reasons why Vanilla Options can be the right choice for forex traders:
* The risk is limited, but the profit can be unlimited. In accordance with the previous trading example, if it is in-the-money, the profit is calculated from the size of the price movement minus the premium fee. However, if out-of-the-money, the loss is only limited to premium fees. In addition, the risk of loss is known before you buy the option because it will be listed on the platform when you want to execute it.
* Complementary hedging strategy. The doubt that surrounds taking a trading position is nothing new. If you are trading on spot forex but are not too sure about the chances of successful positioning, then FX Vanilla Options can be a way out to break the deadlock. Let’s say you have a bullish bias for USD/JPY, but for some reason, you are still unsure about its potential. You have opened a buy order, but as a precaution you can buy a USD/JPY call option on FX Vanilla Options, to anticipate the possibility that the price will rise from its current position.
* More flexible than binary options. Vanilla Options gives you the freedom to determine your own strike price as the target price, while binary options tend to set the open price as the strike price. Determining the strike price can be part of a trading strategy, so the flexibility of FX Vanilla Options in this regard can certainly provide more opportunities for your trading success.
Advantages and Risks of using Vanilla Option
The advantage of using Vanilla Options is the ability to control the underlying asset at a lower cost than buying the underlying asset outright. In addition, options can be used to reduce risk in an investment portfolio. The risk in using Vanilla Option is the potential to lose the entire value of the option if the underlying asset does not move as expected. In addition, the maximum profit that can be obtained from options is limited.
Examples of Using Vanilla Option
An example of using a call option is when an investor buys a call option on XYZ stock at $50. If XYZ’s stock price increased to $60 on expiration date, the investor could exercise his right to buy the stock at $50, and sell it at the market price of $60, making a profit of $10 per share. An example of using a put option is when an investor buys a put option on ABC stock at $50. If ABC’s stock price drops to $40 on the expiration date, the investor can exercise his right to sell the stock at $50, and buy it back at the market price of $40, making a profit of $10 per share.
So, in summary we can conclude that Vanilla Option is a simple and common option that can be used to control the underlying assets at a lower cost and reduce the risk in the investment portfolio. Many consider that vanilla options are speculative trading transactions, because the instruments being traded are not given the right to buy and sell the underlying asset, only given the right to buy and sell assets with a set time limit. So the set liquidity tends not to be transparent and controlled by the broker. So it is vulnerable to the influence of the dealing desk.