What are vanilla options, and how do they work?
Vanilla options, commonly referred to as vanillas, are a kind of financial derivative that presents multiple simple trading opportunities and a world of possibilities for traders. This comprehensive guide will delve deeper into the world of vanilla options, answering what they are and how they work.
An overview of vanilla options
Vanilla options are a type of options contract. These financial instruments give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (known as the strike price) within a specific timeframe. When you trade vanilla options with Deriv, you’ll get a payout if the contract is successful.
To fully grasp how vanilla options work, it’s essential to understand key terms and concepts, including the option premium, expiration date, and the options’ intrinsic and time value.
Call and put options: The two types of vanilla options
Vanilla options primarily come in two forms: call options and put options.
How do vanilla options work?
To buy a vanilla option, the trader pays a premium (also known as buy price or stake amount) to the seller. The premium is determined by several factors, including the underlying asset’s current price, the strike price, the expiration date, and the underlying asset’s volatility.
If the holder of a call option decides to exercise the option, they must pay the strike price to the seller and will receive the underlying asset or a payout as done on Deriv if the market moves in their favour. If the holder of a put option decides to exercise the option, they must sell the underlying asset to the seller at the strike price.
Payoff structure of vanilla options
The payoff structure of a vanilla option depends on whether it is a call or put option and whether it is exercised or expires unexercised.
Call and put option payoff
If you decide to exercise your call option and it moves in your favour by the end of the selected duration, you’ll receive the difference between the strike price and the underlying asset’s price. However, if the underlying asset price is below the strike price, the call option will expire unexercised, and you’ll only lose the premium (initial stake).
Similarly, if the underlying asset price exceeds the strike price, the put option will expire unexercised, and you’ll only lose the premium (initial stake).
Key points to remember
Vanilla options provide a flexible financial instrument that allows buyers to secure the right to buy or sell the underlying asset(s) at a pre-determined price within a specific time frame. They come in two types: call options for when prices are expected to rise and put options for when prices are predicted to fall. On Deriv, these contracts have payouts rather than the actual asset.
It’s crucial to remember that trading in vanilla options carries significant risk. Therefore, it’s advisable only to trade them if you clearly understand the risks involved and have a well-defined risk management strategy.
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Disclaimer:
Trading is risky. Past performance is not indicative of future results. It is recommended to do your own research prior to making any trading decisions.
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