In the UK, a listed stock option is an agreement between two parties to trade a number of shares at an agreed price within a specific period. The shares are listed on a stock exchange, and the option is traded.
The party who buys the option is known as the holder, while the party who sells it is known as the writer. If the holder decides to exercise their option, they will pay the strike price to the writer.
The strike price is determined at a level where there is likely to be some demand for the shares. For example, if shares in Company XYZ are currently trading at £10 per share, you might set the strike price for a call option at £12 per share. If you are the holder, it gives you the right to buy shares in Company XYZ at £12 each, even if the market price has risen to £15 per share.
If the holder decides not to exercise their option, they will forfeit the premium, and the writer keeps it.
What are options used for?
Options can be used as speculative investments or as a way to hedge against other investments. For example, a farmer might buy a put option on wheat futures to protect themselves from falling wheat prices. Options are traded on many different exchanges worldwide, including the London Stock Exchange (LSE).
You can use options to bet on the direction of a stock market or the performance of an individual stock. For example, if you think that Company XYZ’s share price will fall, you could buy a put option with a strike price below the current market price. If the share price falls, you could exercise your option and sell your shares for more than they are currently worth.
However, if the share price rises above the strike price, you would not exercise your option and forfeit the premium.
Why invest in listed stock options in the UK?
There are many reasons you might want to invest in listed stock options in the UK.
One reason is that they can offer greater flexibility than other investments such as shares or bonds. For example, you can choose the strike price at which you want to buy or sell shares and the period you want to do so.
Another reason is that options can provide a way to hedge against other investments. For example, if you own shares in Company XYZ and are worried about a fall in the share price, you could buy a put option with a strike price below the current market price. It would give you the right to sell your shares at the strike price even if the market price falls.
Finally, options can be used as a speculative investment. For example, if you think that Company XYZ’s share price will rise, you could buy a call option with a strike price above the current market price. If the share price rises, you could exercise your option and buy shares at the strike price, even if the market price has risen further.
However, if the share price falls below the strike price, you would not exercise your option and forfeit the premium.
Risks associated with listed stock options
There are many risks associated with listed stock options.
One risk is that the shares may not perform as well as expected, and you may not make a profit on your investment. Another risk is that the share price may fall below the strike price, and you may have to sell your shares at a loss.
Another risk is that the company whose shares you are buying may go bankrupt, and you could lose all of your investment. Finally, options are a complex financial instrument, and there is a risk that you do not understand how they work. It could lead to you making losses on your investment.
If you are interested in investing in listed options, check out Saxo for more info.