Options trading is a popular form of investment in the UK. It’s a way for companies and individuals to make or lose money on an investment with a fixed number of outcomes. A put option makes you money if the stock price goes down, while a buy option will increase in value as the underlying security increases.
The critical thing here is that whatever happens, your loss or gain is set from the outset. This article will explain more about what this entails, how it works and whether it might be suitable for you.
Option basics
An option gives you the right but not the obligation to buy an asset at a specific price – known as ‘the exercise price’ – within a specific period. If you don’t exercise the option after that period, it expires and becomes worthless.
Two main types of options: calls and puts
There are two main options available: calls and puts, though each serves slightly different purposes. A call option will make you money if the share price rises; conversely, a put makes you money if the stock falls in value. While the former is more familiar with individuals, companies often opt for puts because they can limit their downside risk while still allowing them to profit on the increase in value.
Both calls and puts have expiration dates, after which time they become void even if the underlying asset has not reached that point yet. Therefore when trading contracts, you aim to sell before this date, unless, of course, you’re holding onto one with hopes it increases significantly in value before then. A call option gives you the right to purchase a security at a set price, known as the ‘exercise price’ within a specific period. If that time passes without it being executed, it expires and becomes worthless.
Making money with this strategy means buying when the price is low and selling when it’s high. An investor would do well to choose their words carefully when describing this technique, though because if they say they are ‘buying’, in reality, they have already purchased an option on that stock, which might potentially turn out to be worthless even if the underlying asset rises in value after that (at least by this predetermined date.)
On the other hand, if you end up holding onto an option during events after buying an option until they expire, your losses are strictly limited to the price of that option. In other words, you can’t lose more than what you paid for it as long as you hold onto it until the end.
Calls and puts explained
A call is an agreement giving the owner the right to purchase a security from the contract writer at a set price on or before a given date. The buyer of a call has bought insurance – if the value goes up, he makes money on something going in his direction. If not, he’s at least protected by being able to buy shares at a lower rate than they’re worth elsewhere. Of course, shares aren’t changing hands during this process; instead, there’s just a transaction involving the difference in value between two options.
A put is an agreement giving the owner the right to sell a specific security at a set price on or before a given date. This means that you buy them when you think prices will fall and sell when they rise. You can also view this as good protection for shares you already own because there’s no need to transfer ownership.
The bottom line
There’s a reason why investors like to buy and sell options in pairs. Buying an option is buying insurance, just in case, things go in your favour within the given period. While this isn’t going to guarantee you returns that are any better than if you had just invested straight into a single company or asset, it will allow you to ensure that whatever does happen, then you’re only minimally affected by it. New investors interested in trade options uk should contact a reputable online broker from Saxo Bank.
