Options are financial products used by investors to make profits or reduce risks on current investments. Both of these are agreements to purchase investments at specific prices by specific dates.
Options trading give the investor a right, yet not an obligation to buy or sell shares at special prices and at any time, so long as the contract is still valid.
Call and Put Options
There are two types of options trading, call and put options. A call option is an offer to buy stocks at a particular price or strike price before the expiry of the agreement. A put option is an offer to sell a stock at a specific price.
In both cases, options trading are a form of investment and offer to buy and sell shares, but are not an accurate representation of ownership of the assets until the agreement’s finalization. For instance, an investor opens a call option to buy a particular stock at a strike price of $100 within three months to come. The stock now is trading for $99.
If the stock leaps to $110, the call buyer is allowed to exercise the right to buy the stock at $100. The same buyer can immediately dispose of the stock for $110 and get a $10 profit for each share. On the other hand, the option buyer can dispose of the call and keep the profit, as the call option share is $10 for every share. If by the time the contract expires, the option is below $50, the option is not worth anything. The call buyer’s upfront payment or the premium is lost. Of you want to know more, read this article .
The call option buyer’s risk is limited to the upfront premium. The premium fluctuates all through the contract’s lifetime. The premium is based on factors such as the difference between the strike price and the underlying asset’s current price. This is as well as the amount of time remaining on the contract. The investor, who opened the put option, or the option writer, gets the premium.
The option writer has a lot of risks. In the same example, if the stock shoots up to $200, the option writer will have no option but to purchase the shares at $200 and sell them to the call buyer for $100 a share, thus losing $100 per share. Both the option buyer and writer can close their positions any time they choose to by purchasing a call option, bringing them back to the start. The difference between the premium and cost of buying the option or leaving the trade is the profit or loss.
A put options trading is the right to dispose of shares at the strike price or before the contract expires. Traders buy this option hoping the underlying stock’s prices will fall. For example, if an investor has a put option to sell ABC at $200, and the stock’s price decreases to $180 before the option expiry, the investor will get $20 profit per share minus the premium cost. If the price of ABC is above $200 on expiry, that option is useless, and the investor loses the upfront premium
Both the put buyer and writer are allowed to close out the option to close in a profit or loss before expiry. They can do this by buying or selling the option. The put buyer might decide to exercise the right to dispose of the strike price.
Options trading in the UK exchange are run via a market- making system for the provision of liquidity. The exchange appoints option traders who are dealers/brokers as market makers and must quote bid and offer prices for option contracts.
When an option is traded in the UK exchange, there are transaction costs that include SFC levy, brokerage commission, trading tariff or exchange fee, and an investor compensation levy. To exercise any option, you also need to pay a fee.
Trading options in UK are traded in the exchange as an OTC (Over the counter) or sold through a tailored contract or a dealer network, or as a standard contract.