The ins and outs of trading options
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Options do not always have a good reputation because people view them as incredibly risky. This is true, they are extremely high-risk high reward tools for trading and speculating on the markets. All Option contracts work the same way; when you understand what a stock option is you will also understand how an option on a commodity works.
Options come in two primary forms, Calls and Puts, and as most readers of this site are interested in the stockmarket we will mainly be focusing on equity options. A ship can therefore get easily damaged if it sails trading uk stock options close to the berg even if the visible part of the ice is some distance away.
But to have a proper grasp of how they really work you also have to delve below the surface. This means that you should not contemplate using options until you have a proper understanding of exactly how they work and their subtle nuances. Please don't forget this because a lot of money continues to be lost by new option traders who dive into the deep end without the proper knowledge and experience.
And knowledge in the markets always carries two advantages. Call options generally rise when trading uk stock options underlying asset rises in price. For trading uk stock options, Call options on Vodafone will generally increase when Vodafone rises in price. Without it the statement would say ' Call options in Vodafone increase when Vodafone rises in price ' but that would be wrong.
There are times when the underlying share rises in price and the Call options decrease in price. Conversely there are times when Vodafone might decrease in price but the Call options increase in value. This can be due to many factors but the main one relates to what is called option volatility. We've written a dedicated page as to what option volatility is, how it worksand why it is so important when trading options.
Don't even think about trading them until you understand how volatility works and influences the price of all options.
Put options generally rise in value when the underlying asset falls in price. For example, Put options on Sainsbury's will generally rise in value as Sainsbury's share price falls.
And as with Call options the word ' generally ' is important and it's related to how volatility is used in the pricing of all option contracts. All options expire at some stage in the future, so they can only have value for a set period of time.
They are therefore known as ' wasting assets ' because the price can decrease or waste away the closer it gets to its expiration date. This makes sense if you think about it. As indicated above an option only lasts for a set time period. But if the stock doesn't start climbing as the days tick by the chances of it rising by more than a certain percent start to diminish and hence the value of the option will decrease. But as the days drift by the chance of the stock rising significantly also diminish and therefore the price of the option declines over time.
An option is always priced in points or as many refer to them, ticks. The point value is then multiplied by how many shares the option is on. Most London shares, unless they're of a very high value, are on 1, shares.
But remember, equity options for shares traded in different countries will be trading uk stock options. For example, in the US most options are on shares. Trading uk stock options value is the amount by which the premium price of an option exceeds its intrinsic value that is if it has any intrinsic value.
There are also other phrases that are used to describe in-the-money and out-of-the-money options which are self-explanatory. An option gives the holder the right but not obligation to buy a set number of trading uk stock options at a set price on or before a set period of time. Options are tradable financial products. Most of them are not used to actually convert into the underlying shares. Commissions aside, it doesn't matter which of the above you do, both will result in the same profit.
This is why the phrase ' right but not obligation ' is important when defining options. Just because you might have a profitable option position you don't have the obligation to exercise the option into shares and hence generate the profit. Most options therefore are not exercised. Options are therefore flexible financial tools. When dealing in options there are two styles, European and US. Confusingly the terms have nothing to do with the different continents or shares and financial products listed on the two continents.
Of course the option can still be freely traded in the market place enabling a profit or loss to be taken. All options on UK equities are US style and are therefore more flexible.
Personally I wouldn't worry too much which style of options to use because for most retail clients it is immaterial. But if you have the choice it's simple to work out which style trading uk stock options use - always trade where the majority of trading is being done. Look at the daily volumes and you'll trading uk stock options the vast majority are traded European style - that is therefore where you should trade.
This is because the busier a market the tighter the bid offer spreads. Never forget that the cost of doing business in the financial markets is so important to overall profitability. The more you pay in costs the less overall profit or more overall loss you will make.
Some traders think of costs as a tax. And it's hard to find people who want to pay a higher tax percentage of their income!
Shorting means profiting from declining prices, and it's a universal phrase in trading. All of these trades will make money if the shorted product declines in price but trading uk stock options lose money if it rises. Shorting options, for those that are trading uk stock options used to shorting in general, can be somewhat tricky to understand.
But work at it because it's easy once you get to grips with it. Understanding Shorting being able to make money via falling prices. I often say that correctly understanding the concept of shorting is like learning to ride a bike.
It takes time, but once you know how you'll never forget. You also can't kid yourself that you can ride a bike - you know if you can or can't.
Likewise, when you understand shorting you'll know you understand it. Understanding how shorting works in options is important because many option strategies involve what are called spreads. A spread is where 1 or more option is bought and 1 or more option is simultaneously sold short. Spreads are discussed in more detail on the Options Strategy page. But with options you can also make money out of sideways movement.
The shorter time they have to expiry the cheaper trading uk stock options become. Some traders therefore use options to take advantage of expected lacklustre trading.
They do this by selling short Calls or Puts or a combination of the two. Important - Shorting is an excellent way to make money with options but it should never be done without. But not many people trade 1 option, normally they'll trade at least 5 and possibly up to 50 contracts.
Do that sort of size, get the trade disastrously wrong, and options can easily blow your entire trading account - it's happened many times in the past, even to very experienced option traders. So I repeat - do not even trading uk stock options shorting options when you are just starting out as you might open yourself up to the risk of potentially horrendous losses.
Many people new to options believe they've found an almost perfect tool because the financial markets can be and are often extremely volatile.
And highly volatile trading uk stock options can if you get them wrong lead to nasty losses. But with options you theoretically have the best of both worlds. But at the same time they forget the Achilles heel of an option if bought - it's a wasting asset so will always expire at some date in the future.
Therefore it can lose all its value as the days tick down to expiry. And even a 1 day or even 1 week can be the difference between spectacular profits and zero gains. To have a good chance of making money in options, or correctly using them to reduce trading uk stock options, I'm going to be brutally honest.
And if you don't attempt to delve below the surface to explore option theory in more detail it's going to be extremely tough to show a profit over time. My advice is simple, use one of these two strategies to have a good chance of making money trading uk stock options options.
For this you only need a solid understanding of their basics and fundamentals. Do this and you can add options to your financial toolbox. A handyman carries a bag of tools all designed for certain jobs. He'll use a chisel for wood and a wrench for plumbing etc.
A good stockmarket operator should also have many tools at his disposal. He can use shares, CFDsspread bets and options. Given any trading uk stock options of trading situation one trading uk stock options might be better than the other. For example, if he wants to use leverage and short profit from falling prices an individual share, CFDs trading uk stock options Spread Bets would work well.
For another trade idea options might be the best tool to use. But you've got to know how to correctly use them and which options to use. For example if it is the beginning of April and you're extremely bullish should the April, May, June or July calls be bought. You don't need to be an options boffin to carry out that sort of analysis but you need to trading uk stock options an trading uk stock options grasp of the basics. To summarise - If you plan to use options occasionally just learn the basics and don't worry too much about the really technical and mathematical side to their nature.
You have to dive deep below the surface using the trading uk stock options example trading uk stock options explore and understand the subtler and finer points of option theory. You also have to rely heavily on computer power but it is unnecessary to have an expensive PC or software. How do you get this education? You can teach yourself, which will be difficult unless you're already mathematically gifted, or you can get somebody to teach you.