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How to Use Options CFDs for Speculation and Hedging
Date Modified: 26/07/2023
What is Speculation?
A speculator is generally a trader who is looking for a significant gain in a short period of time. An investor on the other hand is one who intends to make a profit in the long term, when the asset is expected to move in a certain direction, but over a longer period of time.
How to Speculate with Options CFDs
Speculators generally try to make an educated guess about the direction of their trades over a short period of time.
Here is an example of where Options CFDs come in:
A speculator believes Apple will beat expectations at its earnings announcement in the next couple of days. They buy a call option with a Strike Price at, or just above the current share price. When stronger earnings are announced, the share price rises significantly which also sends the price of the Call option higher. This speculation is correct and the trader can close the position and profit by selling the Call Option at a higher price.
In contrast, if the speculator believes that the price will decrease in value, a Put Option can be purchased. If this speculation is accurate and the underlying instrument’s price falls, the speculator can sell the Put Option at a higher price.
However, if the speculation isn’t correct and the stock price moves in the opposite direction, the option might lose value and the position will close at a loss.
What is Hedging?
When traders decide to hedge, they do so in an attempt to protect their portfolio from adverse price movements and to try to protect themselves from potential losses. For example, this could be done by purchasing a Put Option as a hedge against an underlying long portfolio position.
Illustrative prices.
How to Hedge With Options CFDs*
You can hedge with any underlying instrument, but it takes research and experience to know when hedging could be beneficial. Here is an example of a hedge with Options CFDs:
Let’s say Sarah had a long position in oil. She believed that in the long term, the price of oil would continue to trend higher; however, she was a little concerned that there could be some short term falls due to current global conditions. Therefore, to counteract the potential loss, she could have bought a Put Option CFD on oil (a derivative) which would have gained in value if the oil price fell - thus offsetting part of the loss incurred by holding a buy position on oil.
*Please remember that hedging on the Plus500 platform can only be carried out if it is not conducted in breach of the terms of the User Agreement on your own account.
Final Thoughts
A speculator attempts to predict price movements on an underlying instrument in a short period of time while taking advantage of leverage. Speculating on Options CFDs can be a great way to trade for those seeking quick returns but also understand there is greater potential for loss. Also, Options CFDs can be a great way to hedge a portfolio to attempt to mitigate potential loss.
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Options FAQ
When you trade options you are speculating on the future price (strike price) of an underlying instrument such as a stock, index or commodity. Plus500 offers two types of options CFDs: Call option and Put option - you can Buy or Sell both types. If you enter a position on a Call/Put option, you are essentially entering a contract on the price an underlying instrument will reach (or surpass) at the expiry date.
Puts – A buyer/seller of a “Put Option” expects the price of the underlying instrument to fall/rise.
Calls – A buyer/seller of a “Call Option” expects the price of the underlying instrument to rise/fall.
For example, here is a breakdown of an option on Meta stock:
Call 125 | Nov | Meta
- Call – The option type (can be either Call or Put).
- 125 – The strike price, i.e. the price you assume the underlying instrument will surpass at the expiry date.
- NOV (November 2018) – The option’s expiry date.
In CFD trading, a popular form of day trading, your profit (or loss) is determined by reference to the movement of an option price. You are not buying or selling the option itself.
Plus500 offers a range of Call/Put options CFDs. For a list of available options, click here.
Furthermore, to learn more about Options CFDs, check out our article on "What Is Options CFD Trading."
Trading on options has some important advantages:
You can experience higher volatility – percentage changes in options tend to be much more significant, meaning they can potentially deliver greater returns (along with greater risks).
It's possible to open larger positions with lower initial margin as options' prices are substantially cheaper than their underlying instruments. For example, Alphabet (GOOG) is viewed by some traders as an expensive stock, while the price of an Alphabet option can often be much more affordable - meaning you can buy more units for the same amount of initial capital.
You can diversify your positions by trading on various strike prices. A strike price is defined as the rate the underlying instrument needs to reach by the expiry time in order for the trade to be in profit. We offer multiple Put/Call options CFDs for each underlying instrument.
Plus500 only offers trading in options CFDs. These options CFDs give you an exposure to changes in option prices, they are cash settled and cannot be exercised by or against you or result in delivery of the underlying security. Therefore, when the option CFD reaches its expiry date, the position will be closed.
Plus500’s options CFDs allow you to amplify your market exposure without the need for a larger amount of capital. With a leverage of up to 1:5, for every $1,000 you deposit you can trade up to $5,000 worth of options. Accordingly, any potential profits or losses will be multiplied.
For example, presuming the stock price of Apple is $200, while the current price of a Call option CFD for $250 (Call 250 | Nov | Apple) is $12 per option. With $120, you could open a trading position on 10 options, valued at $600:
(10 Options x Option Price of $12) x Leverage of 5 = (10 x 12) x 5 = 600.
Every option has a predefined expiry date. Typically set for one month ahead. As opposed to regular options traded in the market, Option CFDs' expiry date is set a few days before that of the underlying options. This is due to very low trading activity on the related contract at this time.
On the date of expiry, the option CFD’s last price is based on the last available rate (and not zero).
The main factors determining the price of an option include: (a) the current price of the underlying instrument, (b) the level of volatility in the market, (c) the expiry date and (d) the option’s intrinsic value, defined as the value any given option would have if it were exercised at present time.
In addition, option prices are heavily influenced by their supply and demand in the market.
Prices of options CFDs are referenced to the price movements of the options. When financial markets experience high volatility, Options CFDs’ percentage change tends to move more significantly than the underlying stock or index, due to an increase in implied volatility.
Example 1: Alphabet (GOOG) is trading at $1,000, and you buy a Call option CFD of $1,100 for one month from now at $70. Two weeks later, Alphabet’s price goes up to $1,050, and the option CFD’s price is now $90. As such, your potential profit is 90-70 = $20 per option CFD. This is equivalent to a yield of 28% (20/70 = 0.28), which is much greater than if you would have bought an Alphabet share at $1,000, and profited 5% (50/1000 = 0.05).
Example 2: Alphabet (GOOG) is trading at $1,000, and you buy a Call option CFD of $1,100 for one month from now at $70. Two weeks later, Alphabet’s price goes down to $950, and the option CFD’s price is now $50. As such, your potential loss is 50-70 = -$20 per option CFD. Equivalent to a 28% change of in the price (20/70 = 0.28), as opposed to having bought an Alphabet share at $1,000, and lost 5% (50/1000 = 0.05).