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Trading Compound Options
An options trading style similar to the Russian dolls that nest inside one another is trading compound options. Trading compound options is trading an option on an option. In trading compound options there are two exercise dates. As with trading European style stock options the first contract is only exercised at maturity. In the case of a call contract the buyer will exercise the option if the price of the underlying equity has gone up sufficiently above the strike price of the contract. If the price of the equity is not high enough at maturity the contract is still exercised but in such a way as to give the buyer a second chance in trading compound options. The prices in trading compound options reflect the second chance aspect of having two back to back chances for a profit.
Calls and Puts in Trading Compound Options
In trading this trading style one still follows profitable options strategies by analyzing both fundamentals and technical factors. A call in either the first or following option gives the buyer the right to exercise the options contract and purchase the underlying equity no matter how high the price might go up. A put gives the buyer the right to sell the underlying equity no matter how low the market price might fall. In each case the buyer is under no obligation to execute the contract and will do so only if it is profitable. The difference in trading compound options is the second chance aspect of the second contract. If in a call contract the price does not rise sufficiently the options contract is exercised and a second contract takes its place. The same happens with a put contract.
Contract Duration and Time Value