Options trading has become an increasingly popular way of earning passive income and hedging risk in the UK. It allows investors to speculate on the future movement of a stock or security without owning it outright. Therefore, beginners can take advantage of low-risk investments while still having the potential to make significant profits if they correctly predict how their chosen asset will move in price. This article will discuss everything beginners must know about options trading in the UK, including types of options available, associated risks and rewards, tips for success and more.
Types of options
Options trading involves contracts between two parties, giving the buyer the authority to buy or sell a security at a predetermined price and time. The options available in the UK include calls, puts, covered options and straddles.
Calls
Calls are options that give the buyer the authority to purchase a security at a specific price before the expiration date. It is an ideal option for investors who believe the price of an asset will increase by the time of expiry. If their prediction is correct, they can exercise their options and make a profit.
Puts
Puts are options that give the buyer the authority to sell a security at a specific price before the expiration date. It is an ideal option for investors who believe the price of an asset will decrease by its expiry date. If their prediction is correct, they can exercise their options and make a profit.
Covered options
Covered options give the buyer the authority to purchase or sell a security at a specific price before its expiry date and have the underlying asset already in their possession. It is an ideal option for investors who believe the market will move in their favour, allowing them to profit without incurring additional costs.
Straddles
Straddles involve purchasing options with both calls and puts on the same security at the same strike price and expiration date. It is an ideal option for investors who believe an asset will move significantly in either direction and want to take advantage of the volatility. If their prediction is correct, they can exercise both options and make a profit.
Associated risks and rewards
Options trading can be a profitable venture; however, it is crucial to understand the associated risks and rewards. The most significant risk in options trading is that if the option expires out of the money, then the investor will incur a loss. Additionally, options prices are subject to volatility, which can change prices rapidly and significantly.
On the other hand, options trading also offers significant rewards. If an investor correctly predicts how security will move in price, then they can exercise their options and make a profit. Additionally, options traders can leverage their investments using options contracts with higher premiums than their current equity. Therefore, options traders can earn more money by investing in options contracts.
Tips for success
Options trading can be an incredibly profitable venture; however, it is crucial to understand how options trading works and the associated risks before investing. To ensure success when options trading, beginners should consider some pro tips.
Research options brokers
Options trading brokers in the UK vary regarding services offered, fees, and options contracts available. Therefore, it’s important to research options brokers before investing with them. It will ensure that investors get the best value for their money and can access options contracts that fit their trading strategy.
Start small
Beginners should start options trading with small investments and gradually increase the size of their options contracts as they gain experience. It will help minimise loss and allow investors to learn without risking too much capital.
Understand options pricing
Options pricing is integral to options trading, and understanding it is essential for success. Options pricing includes factors such as time value, volatility premium, intrinsic value and more and can be complex to understand. Beginners need to do their research before investing in options so they can have a better understanding of options pricing.