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Please remember that when you trade, your capital is at risk. Options trading is a particularly complex and risky trading strategy. A recent study using data from the Chicago Mercantile Exchange (CME) showed that 83% of all options on stock indices expired worthless.
Contents:
Options trading is the process of buying and selling various types of options to generate a profit.
An option is a contract that gives the holder the right but not the obligation to buy or sell an asset in the future.
There are many different types of options, and investors will buy them for a wide variety of reasons. Some use them as an insurance policy to protect against price movement on assets they already hold, and others use them as an investment in and of themselves.
One of the defining characteristics of trading options is that it creates the opportunity for a trader to profit when an asset goes down in value as well as up. When you hear of someone ‘shorting’ an asset or a stock, in many cases, they’ll be using options to make this happen.
If you’re looking into trading options in the UK, it can seem pretty complicated to begin with, so we’re going to start with the basics and build into more technical details as we go.
We will start with a straightforward example so you can begin to see the fundamentals of how options work. Say you believe that Apple stock is going to go up, and you want to trade options to make this investment rather than buying the stock directly (we will explain why you might want to do this later).
At the time of writing, Apple stock was trading at around $150 per share. You decide you want to buy an option that will allow you to purchase Apple stock in the future at its current price. The stock price you buy the options at is what is known as the strike price.
An option that gives the holder the right to buy an asset in the future is called a call option. So, you are going to buy call options on Apple stock.
Options contracts are generally sold in lots of 100. For this example, we will say that the options are trading at $5 each. So, to make this investment, you purchase $500 worth of call options on Apple, which will allow you to purchase 100 units of Apple stock in the future for a price of $150 each.
This $500 is known as your premium.
Fast forward one month and say that your prediction was correct, and Apple stock is now trading at $175. Your option is what’s known as ‘in the money’ because you could exercise them for a profit.
The effective profit on your options is the difference between the strike price of your options and the current price, so in this case, it is:
$175 (current price) - $150 (strike price) = $25 per share
100 options x $25 = $2,500
After taking into account the $500 premium you paid for the options, you’ve made a net profit of $2,000.
Now, we mentioned that you could make money on options if the price of an asset goes down as well.
Sticking with our Apple example, let’s say that you think the price is going to go down instead. In that case, you want the option to sell Apple stock at the current strike price of $150, which means you would buy a put option.
This will allow you to sell Apple stock in the future at a price of $150. Assuming the same premium of $500 for the put options, look ahead three months, and we will assume you made the correct prediction again.
Now, Apple is trading at $100 per share, and you have the right to sell 100 Apple shares at $150 each. That means a profit of $50 on each of the options you hold.
$150 (strike price) - $100 (current price) = $50 per share
100 options x $50 = $5,000
After taking into account the $500 premium you paid for the options, you’ve made a net profit of $4,500. So even though the stock has gone down in price, you’ve been able to generate a profit from it.
It’s important to keep in mind that options have an expiry date, after which they are worthless. This is one of the key risks of trading options, as it can mean you lose your premium if your options aren’t exercised ‘in the money’.
Options that are not in a position to generate a profit for the holder are what’s known as ‘out of the money’.
Just because an option is in the money does not necessarily mean it will generate a profit for the holder. The reason for this is that you need to take into account the premium that has been paid for those options.
If an investor holds 100 options with a £3 profit per option (£300 total), they are in the money. This could still be a losing trade if the premium to purchase those options was £500.
So far, we’ve talked about buying options, which give you the right to buy or sell an asset at the strike price. These can be risky, but that risk is limited. Whatever you pay for the premium is the capital you have at risk.
You can also sell put and call options. This is also known as ‘writing’ options, and you are instead selling other options traders the right to buy or sell an asset from you.
The benefits are that you get paid the premiums, which you get to keep if the option is never exercised. The downside is that when you sell an option, you are obligated to fulfil it.
If you don’t already own the underlying asset (known as an uncovered call), this can be a very risky strategy. It means you might have to buy it on the open market at a much higher market price than the strike price.
An option is what is known as a derivative because its value is derived from an underlying asset. In addition to stocks, the most common assets to purchase options on include stock indices, commodities and foreign exchange.
These work in the same way, with the only difference being the asset on which the option’s value is derived. So, for example, you could purchase options based on the FTSE 100, which would allow you to profit from the movement of the overall UK stock market index.
Commodity options allow all traders to invest based on the movement of assets such as crude oil, gold and silver, as well as less common goods such as soybeans, wheat, corn and sugar.
When it comes to the types of options available in the UK, there is some more terminology for us to cover. If you’re going to consider trading options in the UK, you need to have a solid understanding of the different types of options so that you can decide which ones work best for your chosen options trading strategy.
We have touched on some of these already. To recap, a put option allows the holder to sell an asset in the future, and a call option allows the holder to buy an asset in the future.
It sounds simple, but it can be confusing to remember which is which. A simple way to keep them straight is that you “put the stock up for sale” and you “call the stock in” to buy it.
Despite the misleading names, European and American Options have nothing to do with the location of the company or asset the options are based on. Instead, they are terms used to describe two different styles of options exercise.
As we mentioned before, options do not stay open indefinitely. All options have an expiry date, after which they will either be exercised for a profit or expire worthless.
European options can only be exercised at the expiration date. That means they have to be in the money on the day of expiry to have any value.
American options, on the other hand, can be exercised any time up until they expire.
While American options appear a lot more flexible, European options tend to be much more common. This might seem restrictive for investors, but it is important to remember that trading options prior to expiry is common practice.
A European option may not expire until 22nd August 2023, but if it is in the money on, say, 4th January 2023, then there will likely be a secondary market available to sell this to another options trader at a profit.
One of the ways traders can sell calls or puts is via covered or uncovered options.
A covered call option is a type of option where a trader sells someone the right to purchase an asset they already own. Because they own the asset itself, they hold a ‘long’ position. Should the buyer of the option wish to exercise the call option, the trader will simply hand over their stock. This will be at below market value, but nevertheless, it limits the overall loss that can be incurred.
An uncovered or naked call option, on the other hand, is a type of option where the trader does not own the asset they are selling the option on. Theoretically, this means that the potential downside is unlimited because the trader will need to purchase the stock on the open market at whatever price in order to fulfil the obligation to the buyer of the call option.
A covered put is the same thing, with the difference being that the seller of the covered put already owns a ‘short’ position in the stock or asset.
Leverage in options trading refers to the way in which options can be used to multiply the power of your capital. Because options have a leverage factor, investors gain a much greater exposure to an asset than they would have by investing directly into it.
In the first example of using Apple stock, we explained that a trader might want to use options for the position rather than investing directly. The most likely reason to do that is to gain access to leverage in order to increase returns.
As we covered, a trader who made a call that Apple stock was going to increase from $150 to $175 would potentially profit $2,000 after the $500 options premium was deducted.
Say that same investor instead had decided to simply purchase Apple stock. For the same $500 investment, they would have been able to purchase 3.33 shares. When the price went up to $175, their total profit would have been just $83.25.
That is significantly less than when trading options instead.
However, as is always the case with leverage, the potential losses are higher, too. If you got the prediction wrong and Apple stock went down to $140 at the expiry date, your options would expire worthless, and you would lose your entire $500.
If you had purchased the stock directly, your initial $500 investment would still be worth $466.20, and you would be able to hold it indefinitely and wait for the price to recover.
Even if the price did go up, but only to say $153, the overall options trade would have lost money once the premium is taken into account. Buying directly avoids this issue as there is no premium.
Here are some of the ways you can hedge with options:
A common options trading strategy is to use them to manage risk within a portfolio. It is one of the key ways in which hedge funds manage their portfolios to allow them to potentially generate returns in both bull and bear markets.
The way it works is pretty simple in theory but can get very complicated in practice.
If you think of the risk involved with any investment, you can use options to, at least partially, offset that risk. Going back to our Apple example, say you have a long position in the stock, and you believe it is going to go up over the long term.
You want to hold your position but are also concerned about short-term volatility. You could buy a put option at the current strike price of $150. Remember that means you have the option to sell the stock at $150.
If the price does go down in the short term, you have essentially locked in the floor price for your Apple stock at $150. Now, you might not want to actually sell your stock, but you could sell the options for a profit, which would then offset the short-term loss you’ve incurred on your stock holdings.
If the share price does not go down, the options will expire worthless, meaning they have effectively acted like an insurance policy.
Another common use for options is to hedge out currency risk. Trading options in the UK can be a good way to manage currency risk for assets denominated in other currencies, such as the US dollar.
Buying US-listed stocks while also buying put options on the US dollar would mean the currency risk is removed from the trade while still enabling profit on the shares themselves.
There are many different combinations of options that can be used to manage risk within a portfolio, and it is a common tactic, particularly among professional investment managers.
You can trade options in the UK with platforms such as Saxo and DEGIRO. Trading options is an advanced type of investing strategy, so it is important that you understand how it works, including the potential risks and rewards, before venturing into it.
Follow the steps below to learn how to trade options in the UK:
Options trading requires specialised knowledge of terms and an understanding of how the markets work. To succeed as an options trader, one must understand options trading terms such as calls, puts, premium, strike price, open interest, intrinsic value, in the money, out of the money, at the money, holder, writer, spread, Delta, Gamma, Theta, Vega, Rho, among others. Scroll down to see our short definitions of some of these terms.
Option prices can swing dramatically. As a result of their in-built leverage, these swings can be wider than the fluctuations in the underlying stock or asset that they are based on. With that in mind, it is important to understand which factors influence the options price so that you can gauge whether the fluctuations are simply regular volatility or whether the option is likely to expire worthless.
Three fundamental factors impact the price of an option:
You have to be careful here. If you’re looking at trading options in the UK, many of the online brokers purporting to offer options trading will actually be offering options exposure through spread betting or contracts for differences (CFDs).
These might be something some investors will want to consider, but they are not trading options by using this method.
There are not a large number of options trading platforms available in the UK. Many of the major, well-known companies, such as eToro, do not offer options trading. A couple of examples of reputable trading platforms that offer direct options trading in the UK are Saxo and DEGIRO.
In order to sign up, you will need to complete the usual anti-money laundering processes, which include providing your personal details, ID and information on your income and savings. You will also need to sign a few declarations and confirm your trading status.
As we have discussed, there are many different ways to trade options in the UK and many different types of options you can buy. You need to decide the types best suited to your overall portfolio and the ones you are most comfortable with.
Remember that some options have large but limited potential for loss and gain, while others have unlimited potential for both gains and losses. You need to be sure that you understand how much risk you are taking and the total amount of money you could lose.
When deciding on the best trading strategy for you, a good place to start is deciding on your market thesis and the reason you are implementing options trading into your plan. There are a few main types to consider:
There is a wide range of markets available to trade options. The main asset classes for options trading are:
Before buying an option, you need to identify the strike price you want to enter the position at, your preferred expiry date and your target profit price. Having these set before you enter a position means you have hard rules to follow once the trade is live.
If you do not do this, it is far too easy to let emotions get the better of you and to just “let it ride”. This is a poor options trading strategy as it will inevitably lead to holding a position for too long and eventually losing out.
It may mean that you look back and kick yourself for not holding longer for higher profits, but taking regular, conservative profits is the key to a successful long-term strategy.
Many trading platforms will allow you to set these directly within the app. Stop losses are a common feature that allows the system to execute a trade automatically if the position moves against you by a certain amount.
On the flip side, a take profits order (TPO) does the same thing on the upside, automatically closing out a position once a profit threshold has been hit.
There are many strategies for trading options in the UK. Below is a sample of some of the strategies options traders employ:
As we mentioned earlier, this is a strategy that helps generate income from assets you already own if you expect the stock to rise or remain flat.
By selling the option, you receive the premium, and if the option is exercised, then you simply have to hand over the asset which you already own. That is still not a great result, but the downside is at least limited to the value of the asset.
This strategy acts as a classic hedge against a falling market. It involves an investor buying a put at the same time as they take a long position in a stock or asset. The put allows the investor to sell their long position at the purchase (strike) price, providing them with downside protection for the cost of the premium.
This strategy sees the options trader purchasing both a put and a call option at different out-of-the-money strike prices. This is done when there is a big move anticipated, either up or down. The upside on this trade is hypothetically unlimited, with the downside limited to the cost of buying two options. It means that the move in either direction needs to be large to make this a profitable trade.
This is most commonly used when there is a binary event upcoming, such as the regulatory approval or denial of a new medical treatment or device.
For investors who expect a stock to rise, but only fairly modestly, a Bull Call Spread can be a way to generate a profit via options while also capping the downside risk. It involves buying one call option and, at the same time, selling another.
Both have the same expiry date, but the one being sold has a higher strike price. Selling the call offsets the premium of buying the other and also limits the loss that can be incurred. It limits the gain as well, which is why this trade is not generally used if you expect a stock to rise significantly.
A Bear Call Spread is the same strategy but reversed. This is used when you think a stock is going to fall in price modestly rather than rise.
We’ve compiled a list of the best options trading platforms in the UK. These are our top two UK options brokers.
Please remember that when you trade, your capital is at risk. Options trading is a particularly complex and risky trading strategy. A recent study using data from the largest options exchange in the world, the Chicago Mercantile Exchange (CME), showed that 83% of all options on stock indices expired worthless.
The platforms listed below are authorised and regulated by the UK’s financial watchdog, the Financial Conduct Authority (FCA).
Here are the best options trading platforms in the UK:
Saxo is the UK division of Saxo Bank, a large European bank that allows you to invest in 60,000+ financial products from stock markets worldwide. With Saxo, you can invest in UK and overseas stocks and shares, bonds, ETFs, forex, CFDs, futures, commodities and options. For options trading, specifically, Saxo gives you access to over 3,000 listed options across stocks, indices, interest rates, futures, and commodities from 23 exchanges worldwide and 40 FX vanilla options with maturities from one day to 12 months. With Saxo, you can take advantage of advanced options trading tools via SaxoTraderGO, a powerful trading and analytics tool suitable for both beginners and advanced options traders. Customers can benefit from extensive charting with 50+ technical indicators, integrated trade signals and innovative risk management tools. Saxo also offers a free demo account for customers to practise trading with virtual money before committing real cash.
Saxo offers three pricing tiers depending on the size of your trades - Classic, Platinum and VIP. Commissions on listed options start from $3.00 per lot across equities, energy, metals and more, while spreads on FX options could go as low as 3 pips. Saxo’s suite of products includes a Trading Account, Stocks and Shares ISA and SIPP.
Please note: When you trade, your capital is at risk. 64% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
DEGIRO is an award-winning investment broker that allows you to trade in stocks, bonds, ETFs, options, futures, warrants, certificates and more across 50 international exchanges. It offers tens of thousands of regulated financial instruments that enable investors to diversify their portfolios worldwide.
With DEGIRO, you can invest in up to 200 commission-free ETFs. This means you may not have to pay a dealing charge when you invest in just ETFs (terms apply). When trading complex financial products such as options with DEGIRO, you’ll need to open an Active or Trader account, which involves extra appropriateness tests and conditions. Options trading with DEGIRO cost €0.75 per contract. Dealing UK stocks costs £2.75 per deal, while US stocks cost €1 (~ £0.90) per trade. A currency conversion fee of 0.25% also applies to US stocks. To make sense of the charges, visit DEGIRO.
DEGIRO currently has over two million customers across 18 countries. It is suitable for both beginners and advanced investors, and you can access the platform on any device via the web portal or mobile app.
Please note: Your capital is at risk.
To succeed in options trading, you need to understand the terminology. Here are some popular terms used in options trading to get you started:
There are a number of terms used in investing, and particularly in options trading, which are represented by Greek letters. Collectively, these are known as ‘The Greeks’, and there are some that are used almost exclusively in the world of options trading.
Different platforms will charge different fees when it comes to trading options in the UK. Some charge a fixed commission across different bands, while others charge a spread on the total amount traded.
For example, DEGIRO charges a fixed commission of €0.75 per option contract.
Saxo, on the other hand, charges both a fixed commission and a spread depending on whether you are trading listed options or FX vanilla options. Listed options start at $3.00 per lot (reducing as the size of your trades increases), while FX vanilla options attract spreads as low as 3 pips. The spread is priced in what is known as a ‘pip’, which is equal to 1/100th of 1%, otherwise expressed as 0.0001. These spreads are higher on smaller markets.
Some providers will also offer discounted trading fees if you sign up for a monthly premium membership of their site.
You can buy stock options in the UK from the following options brokers:
It is illegal to sell or market binary options in the UK, and it has been since 2019. With that said, it is not illegal to trade them. This means that, technically, UK traders can use offshore brokers to trade binary options, though the FCA recommends against it.
A binary option is an exotic option type that either pays the investor nothing or a fixed return. It is not possible to sell a binary option for a partial profit. It is simply a win or a loss. In essence, it is a type of fixed odds betting.
To buy options in the UK, you’ll need to open an account with an options broker such as Saxo or DEGIRO. Once you have opened the account, you will be able to buy options on a wide range of markets. Many UK options platforms allow you to purchase options in markets across the world, such as the US, Swiss, European and Hong Kong markets.
Buying options is more complex than buying a stock or an ETF, so you need to understand the different types of options available to buy (and sell). Read through this article to learn the differences and how to buy options in the UK.
As with any investment, it is possible to make large gains through options trading. However, all investments come with risks, and it is possible to suffer large losses. Because of the use of leverage and the ability to make trades with unlimited loss potential, the risks are higher than with other investments, such as buying direct shares or ETFs.
There are four fundamental types of options to trade: buying a call option, selling a call option, buying a put option, and selling a put option. These all have various upsides and downsides, and they can also be bought in conjunction with each other to create a more sophisticated trading strategy.
No, options trading is not gambling. When done correctly, options trading is just another form of investment strategy. Many professional investors use options as part of their overall strategy, and this is not considered gambling.
Binary options are different and are considered a type of gambling.
You should buy options when you are looking to add protection to a portfolio of assets you already hold, when you are looking to profit off the movement of a stock price through the use of leverage, or when you want to employ more complex trading strategies that pay off based on a specific sequence of events.
As with any investment, the way to generate profits is to use knowledge and skill to read the markets and make winning trades. If you find you are regularly losing money by trading options, it is probably time to reassess your strategy. This could mean increasing your education on the investment, looking at a different way to use options to generate a profit or perhaps even moving to a different asset such as stocks or ETFs.
Options trading can be profitable if you are prepared to do the required research and have a strategy in place.
It’s impossible to know how many individual traders are successful. However, a recent study using data from the largest options exchange in the world, the Chicago Mercantile Exchange (CME), showed that 83% of all options on stock indices expired worthless.
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