Options trading: what is it?
All the information you need to know if you want to start trading options. Read more about the options market on Fineco's Newsroom.
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Options tradingWhat is options tradingOptions trading for beginners
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Options trading: what is it and how to trade options
Options trading is a form of online trading done by using derivative financial instruments. Can you trade options in the UK? Options trading is legal in the UK. In fact, it was subject to intense regulation a few years ago to ensure better transparency and security to options traders.
However, before using these investment tools, it’s important to do some research in order to understand what options are and how exactly options trading works. When used properly, they can be a useful choice for traders, but you must know how to use options as part of your online trading strategy.
Options trading explained
An option is a contract with which an investor acquires the right on a financial product. In particular, options allow the holder to buy or sell the underlying activity in a transaction that has to occur at a pre-set price and date. The option holder isn’t obligated to buy or sell the underlying asset, but can decide whether to exercise their right to do so or not.
The buy or sell price is fixed before the contract’s expiry date, depending on the predicted price trends of the underlier at that moment. Options are derivatives, like futures, CFDs and forward contracts, so their value isn’t intrinsic but is tied to that of the underlying activity, for example a bond, a raw material or an ETF.
How does options trading work?
The way that options trading works is fairly simple; indeed, there is no particular secret to it. There are two types of options: call options allow the holders to purchase an underlier, whereas put options allow them to sell it. The choice between using a call or a put option depends on your own analyses of the relative underlier, from which you can then decide to buy a call or a put option.
Using a practical example, let’s imagine an option on a listed company’s stock. If the current price of the bond is £100 but the trader believes that the value can go up to £150 in the upcoming months, they will buy a call option at £120. The trader can buy that bond at any point in the following two months at the agreed price of £120.
If the value of the bond increases and exceeds £120, for example reaching £140 after a month, the trader can exercise their buying right and purchase the bond at £120. In this way, they can resell the bond on the market at £140, making a profit of £20. On the other hand, if the bond price doesn’t increase or exceed £120, then the trader can simply allow the two-month deadline to pass and the contract will be cancelled; in this way, they will only have to pay the cost of the premium that was agreed with the intermediary.
Put options work in the same way. With these contracts you can protect positions, much like insurance policies. For example, if the bond we were discussing earlier could potentially decrease in value in the following two months, then the trader can purchase a put option at £80. If the price falls to £60, the trader sells the bond for £80 if the actual market price is also £60, otherwise they let the option expire and pay the premium to the counterparty.
How to trade options?
Options trading allows you to protect yourself against market fluctuations by safeguarding at-risk positions and making the most of available opportunities. All options involve a cost, a premium on the option that must go to the intermediary regardless of the transaction outcome. The premium equals the maximum loss you can incur should you not activate the option before the contract expires.
Therefore, with options trading you can speculate on the price fluctuations of assets or cover a standing investment at a reasonable cost, for example by protecting yourself should there be a momentary downward trend. To trade options, you must open an investment account via an authorised intermediary that operates with a Financial Conduct Authority (FCA) license.
In this way, you can have access to a trading platform through which you will have the options market at your disposal. To use options properly, you must always plan your strategy, starting with chart analysis through technical analysis, in order to identify potential trends and understand how to make use of them or protect at-risk positions.
Options trading for beginners
Even novice traders can quickly learn how to use options, but you must practise in order to gain experience and develop suitable professional skills. Of course, at the beginning you must proceed with caution in order to understand how options trading works and how to use these instruments to improve your online trading performance.
With Fineco, you have a comprehensive online trading solution with access to a modern and intuitive platform from which to trade lots of financial products such as options, CFDs, futures, bonds and ETFs. With options, a commission per lot of $1.95 is applied to VIX Indices, S&P, DJ Russell and US Stock Options; at any rate, you can operate in 26 global markets with more than 20,000 international financial instruments.
Information or views expressed should not be taken as any kind of recommendation or forecast. All trading involves risks, losses can exceed deposits.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70.82% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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