Understanding Fixed Return Options
WELCOME TO A NEW ERA IN OPTIONS TRADING
Weíre excited to introduce Fixed Return Options (FRO) to retail traders. In fact, weíre probably a lot more excited than other brokers because our CEO, Don Montanaro, is one of the key architects of this newly-listed financial instrument.
FROs are similar to traditional options in some ways, but they do have a few important differences that weíll explore here. Now, letís get down to the nitty gritty, shall we?
NOTE: Throughout this paper, I refer to the price of the ìstockî that FRO contracts are based on. Thatís a bit of an oversimplification. Actually, the underlying securities FROs can be traded on include both stocks and ETFs. So feel free to substitute ìETFî for ìstockî to match your preferred style of trading.
WHATíS A FIXED RETURN OPTION?
Fixed Return Options are a new type of exotic option contract. Donít let the term ìexoticî scare you ñ it doesnít mean FROs are complicated. In fact, as youíll see, theyíre really quite simple. It just means theyíre different from your run-of-the-mill call and put options.
FROs are ìbinary options.î Thatís because there are only two possible outcomes at expiration. Either you achieve your maximum potential profit, or you experience your maximum loss. Thereís no in-between. FROs offer a ìfixed returnî of $100 per contract.
That means buyers of FROs that expire in-the-money receive $100 per contract, and sellers of FROs that expire in-the-money are obligated to pay $100 per contract. When FROs expire out-of-the-money, no additional cash changes hands. The buyer simply loses the premium paid for the FRO contract(s), and the seller keeps the premium.
In other words, buying FROs are an all-or-nothing trade. When they expire in-the-money, they pay $100, and when they expire out-of-the-money, they pay zilch.
THE OVER / UNDER FACTOR
There are two types of FRO: ìFinish Highî and ìFinish Low.î Finish High FROs are in-the-money at expiration if the settlement value is at least one cent greater than the Strike Price. Finish High FROs are out-of-the-money at expiration if the settlement value is equal to or less than the Strike Price.
Finish Low FROs are in-the-money at expiration if the settlement value is at least one cent lower than the Strike Price. Finish Low FROs are out-of-the-money at expiration if the settlement value is equal to or higher than the Strike Price.
continued in Part Two...
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