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What are Long dated Options

Introduction

A long-dated option contract enables you, as the buyer or seller of a particular asset, to acquire or trade a pre-decided price on a certain date in the future. Usually, this duration is more than a year but less than three years. This pre-decided price is often called a strike price as well and the pre-determined quantity is termed as the lot size. This asset could be anything ranging from stocks, currencies, and indices to even precious metals.

Why should you go for long-dated options?

Most investors make their profits by trading options. But as an investor, you must not put all your eggs in one basket. Trading 101 - it is important to diversify. The most common choice for diversification is in derivatives. Here, you can choose any of the underlying asset(s), as mentioned above.

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It is not just the asset, but also the time scope of the trades that has to be diverse. For example, it would be extremely beneficial to hold some contracts which expire in a couple of months and at the same time hold some contracts which expire after a few years with a good long-term profit margin. 

What are the characteristics of long-dated options?

Common option contracts usually have an expiration period of three months. This is where long-dated options come in and it is important to understand their salient features. Here’s a comprehensive list of all the features of long-dated options:

  1. The strike price and lot size are predetermined. This allows traders to mitigate any risks associated with time-related fluctuations.
  2. At a minimum, long-dated options need to have a maturity period of nine months. 
  3. While long-dated options mitigate the risk of the market going down, they won’t provide any substantial benefits if the market goes up.

What are the strengths of long-dated options?

Long-dated options offer multiple benefits that encourage you to rely on them. Some of the noteworthy strengths of long-dated options are:

  1. Alleviation of Risk - Long-dated options significantly reduces the risks associated with trading common options. This is achieved by allowing the trader to hold on to the commodity for a longer period.
  2. Opportunity to diversify - Long-dated options are one of the safest ways to diversify a portfolio. 
  3. Flexibility in expiry time: The expiration time for long-dated options is quite long. Hence, the investor has the comfort of assessing the market and trading only when it is favorable for them. 

What are the categories of long-dated options?

Long-dated options are commonly divided into two categories. They are as follows:

  1. Call option: This option is available to buyers. It allows them to profit from an upward movement in the market. That’s because the buyer can still purchase the underlying asset at the price decided previously, irrespective of the shift.
  2. Put option: This option is available to sellers. It allows them to profit from a down move in the market. That’s because the seller can still sell the underlying asset at the price decided previously, irrespective of the shift.

What’s the relevance of long-dated options in the Indian market?

Long-dated options are also known as 'Long-Term Equity Anticipation Securities' or 'LEAPS'. These options contracts are traded publicly. They have the same duration as stated above - usually more than one year and less than three years. However, there is one aspect that balances out the advantage of the security that LEAPS provides. It is the fact that it is only available on the Nifty50 Index and, more importantly; the returns are not as high as the riskier short-term contracts. Although it must be noted that long-dated options are extensively traded in the US markets. 

Closing thoughts

Long-dated options are a great way of mitigating risks that are associated with trading common options. They provide the luxury to buy or sell an underlying at a predetermined price and quantity. It helps avoid the complications that are brought about by sudden shifts in the market. This security is balanced out by the fact that the profit margins are not as high as the common options. But at the same time, you should always try to diversify your portfolio and long-dated options are one of the best ways to do so.

 

Related Articles: How to Make Money In F&O Trading | Know About Future & Options Span Margin Calculator

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