Call and put options are terms that describe the ability of a trader to buy (call) or sell (put) an asset at an agreed price on or before a specified date in the future. They are popular financial instruments used by traders in the UK, as they provide leverage and help reduce risk. This article will explore what traders need to know about call and put options in the UK.
Call options
Before traders begin trading call options, they must learn more about them. Knowing a call option’s critical features is essential to ensure successful trading.
What is a call option?
A call option is an agreement between two parties, the buyer, and the seller, which gives the buyer of the option the entitlement to purchase a certain amount of stock or other assets at a fixed price on or before a specific date. The seller of a call option is obligated to sell their shares at that price as long as it is within the agreed expiration date. Moreover, the buyer of the option does not have to buy the asset; they can choose to let the option expire.
How does a call option work?
When trading a call option, the trader pays an initial premium to purchase the right to buy the asset at a predetermined price. If the underlying assets increase in value, the trader may exercise the option and buy it at that lower price. This option is beneficial as it allows them to benefit from the potential gain in the underlying asset without having to pay the total cost of buying it outright. Additionally, the option can be sold anytime, allowing traders to benefit from the premium they paid upfront.
What are the risks associated with call options?
Trading call options carries certain inherent risks that traders need to know before they trade options in UK.
The option may expire as worthless
If the underlying asset does not increase in value, or if it decreases, the option may expire without any gains for the trader.
Volatility risk
The volatility of the underlying asset can affect the option’s value. The option may become less valuable if the underlying asset’s price fluctuates dramatically.
Put options
Similarly, understanding put options is vital to ensure successful trading in the UK and that traders make informed decisions.
What is a put option?
A put option is an agreement between two parties, the buyer and the seller, which gives the buyer of the option the right to sell a certain amount of stock or other assets at a predetermined price on or before a specific date. The seller of a put option is obligated to buy their shares at that price as long as it is within the agreed expiration date. The buyer of the option does not have to sell their asset; they can let the option expire.
How does a put option work?
When trading a put option, the buyer pays an upfront premium to purchase the right to sell the underlying asset at a predetermined price. If the underlying asset’s price falls, they can exercise the option and sell it at that higher price. It helps them benefit from the potential drop in the underlying asset without putting up the total amount of money upfront. Similarly, the option can be sold anytime, allowing traders to benefit from the premium they paid upfront.
What are the risks associated with put options?
Similar to call options, trading put options carries certain inherent risks that traders must be aware of before they start trading.
Interest rate risk
When trading a put option, the trader may have to pay interest costs if they buy and hold on to an option for too long. It can lead to additional losses, so traders must be aware beforehand.
Opportunity cost
The trader may have to forgo potential gains if the option does not increase in value. By buying a put option, they may be limited to the gains that can be made from just this option, which can lead to opportunity cost.