Options trading is an investment strategy that enables investors to capitalise on potential price movements in security without buying or selling the underlying asset. It involves the purchase of contracts allowing an investor to buy (call option) or sell (put option) a security at a predetermined price on or before an agreed date.
This type of speculative investment, generally employed by experienced traders and investors, can hedge against risks, generate income, and increase exposure to equities while limiting risk. Investors may use options in various combinations to create strategies with different levels of risk-reward profiles.
When it comes to options trading, safety should be the highest priority. After all, when you enter into an options trade, your potential losses can exceed the capital you initially invested. The right strategy can help protect your investment and maximise returns in a volatile market.
A list of safe options strategies used by UK traders
Here are some safe options strategies used by UK traders:
Covered calls or protective puts
One of the safest ways to trade with options is by using covered calls or protective puts. Covered calls involve buying shares of stock and then writing (or selling) call options against them for a premium income. A protective put involves buying a put option on stocks one already owns to protect against declines in their value. Both strategies will provide downside protection while allowing for upside profit potential; however, some differences between the two must be considered when deciding which strategy is right for you.
The primary difference between covered calls and protective puts lies in the risk associated with each option. With a covered call, the maximum potential loss is limited to the premium received from writing the call options minus any gains realised if the stock rises above the option’s strike price. On the other hand, protective put holders face unlimited losses if they buy high enough strikes and stock drops below that value. Therefore, it’s essential to consider how much downside protection you are looking for when determining which strategy is best for your specific situation.
Another options strategy that offers a high degree of safety is married puts. With this approach, an investor buys shares of stock and simultaneously buys a put option on the underlying stock to protect against any declines in the stock’s value. While this strategy provides some protection against losses, it also has risks. For instance, if the options are too expensive, they can eat into your potential profits if the stock rises significantly. Calculating how much you’re willing to pay for a protective put is essential to determine whether it is worth the cost.
The collar strategy
The collar strategy is another safe way to trade with options that combines covered calls with protective puts. The investor buys shares of stock and then sells a call option with a strike price at or above where they currently stand, as well as buying an out-of-the-money put with a strike price below the stock’s current level. This strategy provides downside protection and some upside potential but limits how much you can make from any significant appreciation in the underlying shares.
Swing trading could be the right choice for those looking for an even safer option. This strategy involves buying and selling stocks to profit from small price movements in either direction. Swing traders look for stocks that are volatile enough to generate a quick profit but not so volatile that they will incur significant losses if the market moves against them.
Why do novice traders use a broker when trading options in the UK?
Novice traders often need guidance to think they can trade options independently. However, trading options is complex and requires extensive knowledge about the market and different strategies, which is why it’s highly recommended that novice traders use the services of an experienced broker when trading options.
A broker like Saxo can provide expert advice on choosing which option strategy best suits your objectives. They can help you understand underlying asset prices, contract terms, and expiration dates and provide insight into current market conditions. Brokers are also knowledgeable about the risks associated with each strategy and can advise investors on managing them.
In addition to advice, brokers may offer other services such as analysis of financial markets, access to risk management tools, and automated options trading solutions. By leveraging these services, investors can increase their chances of success when trading options.
When selecting a broker for options trading, it’s essential to consider their experience level and fee structure before deciding. Ensuring they are registered with the Financial Conduct Authority (FCA) is also essential. It will ensure that you are dealing with a legitimate firm that offers fair pricing and reasonable protection in case something goes wrong during your investment activities.
By enlisting the help of a qualified broker when trading options, novice traders have access to professional expertise that could enable them to reap higher returns from their investments while managing risk effectively. Therefore, while it’s possible to trade options without a broker, doing so could be risky and lead to significant losses if done incorrectly.
When trading with options, safety should be your primary concern. Covered calls, protective puts, married puts, and collars are all safe options strategies that can help protect against losses while allowing for upside profit potential. Assessing each strategy to determine which best fits your needs and risk tolerance is essential. By doing so, you’ll be able to maximise your returns in a volatile market without putting too much of your capital at risk.