Options trading is a type of trading that allows investors to see quick and effective results. By predicting an underlying asset’s future direction, investors can profit by buying or selling options.
Pros use four main types of options trading strategies in the UK: covered calls, long strangle, butterfly spread and momentum trading.
Covered call
A covered call is when an investor buys an underlying asset and then sells a call option on the same asset. If the underlying asset price rises, the investor will profit from the call option sale. If the underlying asset’s price falls, the investor will still profit from the sale of the call option but will lose money on the underlying asset. The covered call is the most basic options trading strategy used by many pro traders in the UK.
Long strangle
A long strangle strategy is when an investor buys an out-of-the-money call option and an out-of-the-money put option on the same underlying asset. If the underlying asset price rises, the investor will profit from the call option sale. If the underlying asset’s price falls, the investor will profit from the sale of the put option. The long strangle strategy is a more advanced options trading strategy used by many pro traders in the UK.
Butterfly spread
A butterfly spread is when an investor buys two out-of-the-money call options and sells one at-the-money call option. If the underlying asset’s price expires at or below the lower strike price, all three options will expire worthlessly, and the investor will lose money. If the underlying asset’s price expires at or above the higher strike price, all three options will expire in the money, and the investor will make a profit. The butterfly spread is a more advanced options trading strategy used by many pro traders in the UK.
Momentum trading
Momentum trading is a type of trading that focuses on buying and selling assets experiencing a sudden increase or decrease in price. Momentum traders aim to capitalise on these price changes by buying assets when they are undervalued and selling them when they are overvalued. Many pro traders in the UK use momentum trading as their primary option day trading strategy.
Risks of trading options in the UK
Volatility
The most significant risk when trading options is volatility, the amount by which an asset’s price can change in a given period. If the underlying asset’s price is volatile, it will be more challenging to predict which direction it will move in, making it harder to profit from trading options.
Time decay
Another risk when trading options is time decay; this is the amount by which an option’s value decreases as it gets closer to expiry. When an option is close to expiry, its time value decreases at an increasing rate. If you are holding an option close to expiry and the underlying asset’s price has not moved in the desired direction, you are at risk of expiring worthless and losing money.
Liquidity
Another risk when trading options is liquidity, the amount by which an asset can be bought or sold in a given period. If an underlying asset is not liquid, it will be more difficult to trade it, making it harder to profit from trading options.
Margin
Another risk when trading options is margin, the amount of money an investor must put up to buy or sell an option. If the underlying asset’s price moves against the investor, they may be required to put up additional funds to maintain their position. It can lead to losses if the market moves against the investor.
Assignment
Another risk when trading options is when the option writer assigns the option holder an underlying asset. This process is called an assignment. It can occur if the option is in-the-money at expiration or if the option holder exercises their option. When an option is assigned, the option holder will either receive or have to deliver the underlying asset. Depending on the underlying asset’s price at the time of assignment, it can lead to a profit or loss.
