A call option allows the owner to buy a particular asset on or before a certain date, for a pre-determined price. A put option is the exact opposite, giving the option, but not the obligation, to sell a specific asset on or before a particular date.
A CFD, or Contract For Difference, is a bet, there's no other word for it. But unlike most bets, with a CFD, the punter has the ability to control the outcome. A CFD, like a call or put option, allows the speculator to make spectacular profits in a very short space of time, if the 'bet' was placed at the right time and predicted the right outcome. With a CFD, instead of actually buying or selling a particular asset, the user places a 'bet', called 'maintenance margin' on a particular instrument to rise or fall in value. As the name suggests, the punter is legally bound to pay or receive the difference in the value of said asset over the duration of the trade. If the trade is successful, the difference in the value of the underlying asset is gained, as opposed to just the value of the margin.
Buying options is fraught with danger. A call option only has a value if the underlying asset's price is higher than the strike price of the option when exercised. If the price of the underlying asset is below that of the strike price at the time of expiration, the option will expire worthless, and over 70% of options expire worthless.
A CFD isn't exactly the 'safe option' either. CFD's use leverage to increase the reward for a successful trade, but with greater reward, comes greater risk. Plus500 (OTC:PLSQF) offer CFD services for a wide range of markets, including stocks, foreign exchange, ETF's, commodities and indices. Different levels of leverage are used for different markets, but the principles are simple; A particular asset may be leveraged 1:5, meaning the value of the asset is 5x greater than the 'maintenance margin'. In other words, a $100 CFD has the ability to gain or lose what a $500 asset would have done in the same timeframe. This can be great news, if the underlying asset rises 10% to $550, the CFD has risen 50% to $150. But if the underlying asset loses 20%, it would be worth $400, but the CFD is now worth absolutely nothing, and if the asset lost more than 20%, the speculator would actually lose more than the $100 initial margin.
So why take all the risk?
Over 70% of call options expire worthless, and I could place a 'bet' with a CFD and actually lose more than my initial stake, so why on earth would I allocate cash here instead of the traditional stock market?
Call shorting has long been employed as a method of profiting from those options that expire worthless. The idea is simple; if the option looks likely to expire worthless, short it and buy it back at a lower rate. In other words, sell someone else's options with the promise of buying them back, and when the price falls, buy them back and pocket the difference. Plus500 is a very simple way of doing just that. The software allows users to trade options for indices, and a select number of stocks.
Most options expire in the middle of the month, and when they do, some expire worthless, and some get exercised. I'm interested in the options that expire worthless, as these are much more profitable. I look at the S&P 500 options, and obviously track the value of the S&P in the days and weeks before expiration. Not always, but mostly, there are some options that look almost certain to expire worthless. July's options expired on Wednesday 13 July at 21:00, with the S&P closing at just over 2150. Therefore, the 2050 and 2075 put options had no value, because a put option will only have value if the strike price is above the asset's price (remember, a put option is the opposite of a call option). In the days before the expiration date, I began to short the put options, which is effectively a bet on the market to go higher. However, because the options were so close to expiration, they lost their time value, and expired nearly worthless on Wednesday, which gave a tidy profit on any short position opened just 24 hours before expiration. Plus500 will remove certain options a day or so before expiration, as they are fully aware of the likelihood of expiring worthless, so initiating a short position 2 or 3 days in advance is advisable.
With leverage, comes risk. Even options that look to expire worthless can spike in value if the market quickly turns out of favor, which can cripple an over-leveraged portfolio. As an insurance policy, I keep ~70% of the portfolio in cash, to ensure there is liquidity should things not go according to plan. Using leverage is like dating a supermodel with severe anger problems; when it's going well it's going great, but don't do anything to upset the beast. Don't be greedy, if there is a profit to be had, take it, even if the market cannot possibly go higher in such a short space of time, because it is easy to open a position again, but this time from a position of greater strength, given the extra cash.
Shorting call options is nothing new, and neither is CFD trading, but the combination of the two can be very useful when markets are relatively stable. When there is a large difference between the strike price of an option and the current price of an asset, use this method to profit as the options lose their time value and ultimately expire nearly worthless.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.