22/04/2023
How Options Trading Can Boost Your Investing Performance
If you are looking for a way to diversify your portfolio, hedge your risk, or profit from different market scenarios, you might want to consider options trading. This is a strategy that involves buying and selling contracts that give you the right or the obligation to buy or sell an underlying asset at a set price within a set timeframe.
What Are Options?
Options are contracts that give you the right – but not the obligation – to buy or sell an underlying asset before a certain expiry date. The underlying asset can be a stock, an index, a commodity, a currency, or any other financial instrument. The price at which you can buy or sell the underlying asset is called the strike price.
There are two types of options: call options and put options. A call option gives you the right to buy the underlying asset at the strike price, while a put option gives you the right to sell the underlying asset at the strike price. You can buy or sell options depending on your market view and trading objective.
How Do You Trade Options?
To trade options, you need to open an account with a broker that offers options trading. You can trade options using spread bets or CFDs on our award-winning trading platform1. These are leveraged products that allow you to speculate on the movement of the option’s premium – which is the price you pay or receive to enter or exit an option contract.
When you buy an option, you pay the premium upfront and your risk is limited to that amount. When you sell an option, you receive the premium upfront and your risk is potentially unlimited (although your account balance will never fall below zero). Your profit or loss depends on how the option’s premium changes as the underlying market moves and as the expiry date approaches.
What Moves Options Prices?
Options prices are influenced by several factors, such as:
The price and volatility of the underlying asset
The time left until expiry
The interest rate and dividend yield of the underlying asset
The supply and demand of the option in the market
One way to measure how these factors affect options prices is to use the Greeks. These are mathematical indicators that show how sensitive an option’s premium is to changes in these factors.
Some of the most common Greeks are:
Delta: This shows how much an option’s premium changes for every one-point change in the underlying asset’s price
Gamma: This shows how much an option’s delta changes for every one-point change in the underlying asset’s price
Vega: This shows how much an option’s premium changes for every one-percentage point change in the underlying asset’s volatility
Theta: This shows how much an option’s premium changes for every one-day change in time until expiry
Rho: This shows how much an option’s premium changes for every one-percentage point change in interest rate
What Are Some Options Trading Strategies?
There are many options trading strategies that you can use to achieve different goals, such as:
Hedging: This involves using options to protect your existing positions from adverse market movements. For example, if you own a stock that you expect to rise in value, but you want to limit your downside risk, you can buy a put option on that stock.
This way, if the stock price falls below the strike price of your put option, you can exercise your right to sell it at that price and offset your loss on your stock position.
Speculating: This involves using options to profit from your market view or volatility expectation. For example, if you expect a stock to rise significantly in value within a short period of time, you can buy a call option on that stock. This way, if the stock price rises above the strike price of your call option, you can exercise your right to buy it at that price and sell it at a higher market price for a profit.
Income generation: This involves using options to earn income from your existing positions or idle cash. For example, if you own a stock that pays dividends but has low volatility, you can sell a call option on that stock. This way, you can receive the premium upfront as income and still collect dividends from your stock position. However, if the stock price rises above the strike price of your call option, you will have to sell it at that price and forego any further upside potential.
