What is a Vanilla Option?

A vanilla option is an uncomplicated type of financial derivative contract which gives the holder of that option the right but not the obligation to buy or sell this contract at a given price within a set time frame.

This means that a vanilla options contract has standard features of a contract and is the simplest type of options contract.

Characteristics of Vanilla Options

Vanilla options are simple options which have standard features of an options contract. These features are as follows:

a)      Traders can trade vanilla options on a Call or Put basis, equivalent to Buy or Sell. The trades are usually set at a price which is determined by the broker at the time of the initiation of the trade.

b)      All vanilla option trades have a pre-determined time limit, after which the trade expires. The maximum expiry time for a vanilla contract is 3 months.

c)      The trader can decide to either exercise the contract (i.e. sell a Call contract to the dealer or Buy a Put contract from the dealer), or to allow the trade to expire worthless contract, depending on what the trade objective is.

d)     Vanilla options are traded in contracts, and each contract is made up of blocks of 100 units of the asset. The minimum that can be purchased or sold in an options trade is one contract or 100 units of the asset.

e)      Vanilla options require two parties in a trade.

Assets Traded as Vanilla Options

Several assets can be traded as vanilla options:

a)      Stocks

b)      Currencies

c)      Commodities

d)      Stock indices

e)      Exchange Traded Funds (ETFs)

f)       Bonds

Types of Vanilla Options

Vanilla contracts can be traded in rising or falling markets. Two types of vanilla options contracts exist as far as direction of trade is concerned. These are:

a)      Call contracts

The call contract is used to profit from rising prices and is defined as an options contract that gives the trader the right to “call” or buy the option from the option owner (the dealer) at a specific price and for a specified time frame, without obligating the trader to exercise it on expiry.

b)      Put contracts

The put contract is a vanilla options contract used to profit from falling prices and is defined as an options contract which gives the trader the right to “put” or sell the options contract to another party at a specific price and for a specified time frame, without an obligation on the trader’s part to exercise the option on expiry.

How to Start Trading Options

The first step is to open an account with a regulated vanilla options broker. Vanilla options are leveraged financial products, but the degree of leverage that is offered to traders is small compared with other financial markets such as the forex market. Smaller leverage amounts mean that margin requirements are higher. Traders will therefore be required to come up with significantly larger amounts of money to be used as trading capital. For instance, in the US a vanilla options trader can only use a leverage of 1:20, and requires at least $50,000 to trade vanilla options with full-option brokers. Discount brokerages may require less, meaning that mini-contracts are offered.

Traders are required to submit their govt-issued IDs (national ID card or international passport) as well as a proof of residence (utility bill or bank statement) before they can trade vanilla options. Once a trading account is approved, the trader can fund the account with the trading capital required for the account type, and proceed to execute Call or Put trades.

 

This article was written by easy forex. For more articles please visit their website.