Listed options trading involves buying or selling contracts at a set price by a specific date. Options are typically used as a hedging tool to protect against downside risk but can also be used to speculate on the direction of an underlying asset.
The two main listed options are: call and put options.
Choose an options broker
To trade listed options, you will need to open an account with a broker that offers this service. Not all brokers offer listed options trading, so it is essential to research and choose a broker that best suits your needs. There are several factors for you to consider when choosing a broker, such as platform fees, commission structure, and the range of assets available.
Decide what type of option you want to buy
There are two main listed options: call options and put options. Call options give the holder the entitlement to buy an underlying asset. In contrast, put options give the holder the entitlement to sell an underlying asset at a specified price by a specific date.
You will need to decide which type of option you want to buy based on your investment goals. If you think the underlying asset price will go up, you will buy a call option. If you think the underlying asset price will go down, you will buy a put option.
Choose an expiration date
Options contracts have a set expiration date, at which point the contract expires, and the holder no longer has the right to exercise the option. When choosing an expiration date, you must consider your investment timeframe and objectives.
If you are looking for immediate exposure to the underlying asset, you will choose a shorter-dated option with a nearer expiration date. If you are looking for longer-term exposure, you will choose a longer-dated option with a farther expiration date.
Select the strike price
The strike price is when the holder can buy or sell the underlying asset. When buying a call option, you should choose a strike price above the current market price of the underlying asset. It gives you the right to buy the asset at a discounted price if the market price rises above the strike. When buying a put option, you would choose a strike price below the current market price of the underlying asset. It gives you the authority to sell the asset at a premium if the market price falls below the strike.
Determine the premium
The premium is the options contract price and is typically quoted in per-share terms. The premium comprises two components: the intrinsic value and the time value.
The intrinsic value is the difference between the strike price and the current market price of the underlying asset. If the current market price exceeds the strike price of a call option or is below the strike price of a put option, then the option has intrinsic value.
The time value is the amount by which the premium exceeds the intrinsic value and goes according to the time to expiration and volatility. The closer an options contract is to expiration, the less time there is for the underlying asset to move and, therefore, the less time value. Similarly, a higher degree of volatility will result in a higher premium as there is a greater likelihood for the underlying asset to move.
Place your order
Once you have determined all of the above factors, you are ready to place your order. Your broker will need:
- The type of option (call or put)
- The expiration date
- The strike price
- The premium
You will also need to specify the number and type of contracts you want to buy. One standard contract is for 100 shares of the underlying asset.
Monitor your position
Once your order is filled, you will need to monitor your position and make adjustments. If the primary asset moves in the desired direction, you can let the position ride and hope to make a profit. If the underlying asset moves against your position, you may want to consider making adjustments to limit your losses.
For a list of available listed options in the UK, check out Saxo Capital Markets.