One-Touch Options: Understanding, Examples, and Pros & Cons
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Summary:
One-touch options offer investors a straightforward way to potentially profit from specific price movements in the market. This article provides an in-depth exploration of one-touch options, including how they work, their advantages and disadvantages, and real-world examples of their outcomes.
What is a one-touch option?
A one-touch option is a derivative contract that pays out a premium if the spot rate of the underlying asset reaches a predetermined strike price at any time before the option’s expiration. Unlike traditional options that require the asset to reach a certain price by expiry, one-touch options only need to touch or exceed the strike price once during the option’s lifespan to trigger the payout.
Understanding one-touch options
How one-touch options work
One-touch options provide investors with the flexibility to select the target price, time to expiration, and premium to be received upon reaching the target price. This type of option simplifies market forecasts to a binary outcome – either the target price is reached, resulting in a payout, or it is not, resulting in the loss of the premium paid to open the trade.
Outcomes of one-touch options
When holding a one-touch option until expiration, there are two potential outcomes:
- If the target price is reached, the trader collects the premium paid plus the agreed-upon payout.
- If the target price is not reached, the trader loses the premium paid to initiate the trade.
Similar to standard options, one-touch options can be closed before expiration, allowing traders to manage their positions based on market movements.
Examples of one-touch options
Outcome #1: price approaches target price
Consider a scenario where a trader anticipates a 5% rise in the S&P 500 over the next 90 days. They purchase one-touch options for $45 per contract, with a payout of $100 per contract if the S&P 500 meets or exceeds the target price within the specified timeframe. If, after two weeks, the index rises by 2%, increasing the likelihood of reaching the target price, the trader can sell their options for a profit or hold them until expiration.
Outcome #2: price remains flat or moves away from target price
Suppose a trader expects a 5% increase in the S&P 500 over the next 90 days and buys one-touch options accordingly. However, unexpected news causes the index to drop by 3% within a week, reducing the probability of reaching the target price before expiration. In this scenario, the trader may sell the options at a loss or hold them with the hope of market recovery.
Frequently asked questions
Are one-touch options suitable for small investors?
One-touch options are typically less frequently traded by small investors due to their complex nature and lower liquidity in the market. These derivatives are often favored by institutions and sophisticated traders who have the resources to navigate their intricacies effectively.
Can one-touch options be closed before expiration?
Yes, like standard options, one-touch options can be closed before expiration. This feature allows traders to manage their positions based on changes in market conditions and lock in profits or limit losses accordingly.
Key takeaways
- One-touch options offer investors a simplified way to potentially profit from specific price movements in the market.
- Traders can select the target price, time to expiration, and premium to be received, providing flexibility in their trading strategies.
- However, one-touch options may be less suitable for small investors due to their complexity and lower liquidity.
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