How are listed options traded? - The Malvern Observer

How are listed options traded?

Malvern Editorial 19th Oct, 2022   0

OPTIONS are an important financial tool used by hedgers and speculators to make omni-directional plays on various market. Options are an OTC product traded between participants, and even the most complex option types can be simplified into layered groups of ‘call’ and ‘put’ options. They command vast trading volumes and are popular across the entire spectrum of market participants, but they are also a complex product that retail traders should approach with caution.

What are options?

Options are financial instruments that give the buyer the right, but not the obligation, to buy an asset on a particular date if it exceeds a particular price, known as the strike price.

How do options work?

When you hold an investment, you may require a hedge in the event of its price falling. In that case, you can buy put options which will payout should the price of an asset decline below a certain level. Should the investment not fall beneath the strike price, the option will expire worthless.

This is a powerful tool for investors as it allows you to profit off the otherwise harmful event of your portfolio falling in value. Of course, in order to buy enough options to completely remove the effect of falling prices, you will likely eat into your profits. Complete hedging is rare outside of the FX and commodities markets, as if you have a directional view on an investment you are unlikely to want to fully hedge it.




Call options

Call options are useful for making long investments – the strike price on a call option is above the current market price, and they will become steadily more profitable the further the asset increases above the strike price. This is because you gain the right to buy the asset at the strike price, meaning you can immediately profit the difference between the strike price and the general market price at expiry.

Complex options

Calls and puts can be bought simultaneously and layered to create different payout profiles. These could cap your losses at a certain level, cap both gains and losses, or even provide a certain guaranteed low premium provided the price of the asset does not vary wildly. Strategies like this can be very dangerous, and are best left to financial engineers.


How to trade options in the UK

Making sure you are working with a regulated broker, checking on the FCA website to ensure the firm has the correct licenses, you can buy options on an online account with relative ease. Many firms will require you to certify as a professional investor, as options are a complex product that requires a degree of financial education to understand and use correctly.

The benefits of trading options in the UK

Options allow you to hedge your portfolio from certain risks, to create profits from positive and negative market moves, and to expose yourself to unique risks. Great care is required when trading options, and they are not a product that is suited to the majority of retail investors.

If you are serious about trading options, it is worth familiarising yourself with the terminology of risk, and the metrics known together as ‘the greeks’. These include the effects of time, volatility and interest rates on the price of options, and can help you build accurate pricing models.

The final word

Saxo Markets is an example of a bank / broker offering a range of options contracts to their clients. Checking online will allow you to gain an idea of the different underlying assets available, as well as price history and risk information about options. Options are a very useful but also complex product, with an important role to play in the financial system.

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