The UK market has a lot to offer investors when it comes to options trading. We’ll look at some of the benefits of listed options in the UK and why they may be worth considering for your portfolio.
What are listed options?
Listed options are simply options that are traded on a regulated exchange. They are subject to the same rules and regulations as other financial instruments and are much more transparent than over-the-counter (OTC) options.
How do they work?
Listed options give the holder the right, but not the obligation, to buy or sell an underlying asset at a fixed price within a specified period. The price at which the option can be exercised is the strike price, and the period is known as the expiry date. Options are typically used by investors for one of two reasons – to hedge against market risk or to speculate on future market movements.
Hedging with options
When an investor hedges their portfolio with options, they are essentially trying to protect themselves from losses that may occur if the market falls. It is done by buying put options, giving the holder the right to sell an underlying asset at a fixed price within a specified period. If the market falls, investors can exercise their put option and sell the asset at the strike price, regardless of how low the market price has fallen.
Speculating with options
When investors speculate with options, they are trying to profit from future market movements. It is done by buying call options, giving the holder the right to buy an underlying asset at a fixed price within a specified period. If the market rises, investors can exercise their call option and buy the asset at the strike price, regardless of how high the market price has risen. Conversely, if the market falls, the investor allows their option to expire worthlessly.
Options vs shares
It is important to note that options are not the same as shares. When an investor buys shares, they buy a piece of a company and become a partial owner, which means that they are entitled to voting rights and may receive dividends.
In contrast, when investors buy an option, they are not buying a piece of the underlying asset. Instead, they buy the right to purchase or sell the asset at a fixed price within a specified period. It means that options do not come with any ownership rights.
What are the benefits of listed options?
There are many benefits of listed options, which include
Increased security– because listed options are traded on exchanges, they are subject to strict regulations. It provides a higher level of security for investors, as there is less likelihood of fraud or manipulation.
Greater transparency– all listed options must be reported to the relevant authorities, so there is greater transparency around pricing and trading activity. It makes it easier for investors to make informed decisions.
More liquidity– as listed options are traded on exchanges, there is usually greater liquidity than OTC options. It means that it is easier to buy and sell options and that there is less chance of the price being manipulated.
Lower costs– because of the increased liquidity and transparency, the costs of trading listed options are typically lower than for OTC options.
Better protection from credit risk– when an option is traded on an exchange, the exchange acts as a counterparty to each trade. If one party defaults on its obligations, the other party is still protected. There is no such protection with OTC options, as the parties are dealing directly with each other.
Access to a broader range of options– exchanges offer a much more comprehensive range of options than is available OTC. It means that investors can find the options that best suit their needs.
Greater flexibility– listed options can be traded in many different ways, giving investors greater flexibility in managing their portfolios.
Hedge against market risk– because options provide the ability to buy or sell an underlying asset at a fixed price, they can be used to hedge against market risk. It can help investors to protect their portfolios from losses in falling markets.
Speculate on market movements and hedge against market risk- options can also be used to speculate on future market movements. It can provide the potential for significant profits if the investor correctly predicts the market direction.
Manage risk– by using options; investors can manage the risk in their portfolios more effectively. By carefully selecting the options they trade and using stop-losses and other risk management tools, investors can limit their downside while still allowing themselves to profit from market movements.
For more info, check out Saxo Bank.