What are share options and how do you trade them?

What are stock options?

Stock options are contracts that give you the right, but not the obligation, to buy or sell a predetermined number of a company’s shares at a specified price, on or before the contract’s expiry date. It’s only one of the forms of options trading available.

Let’s look at an example of trading share options. Say you expect Tesla’s share price to rise from $600 to $650 in the coming month. So, you decide to buy a call option at the strike price of $620 – above Tesla’s current share price but still a way from your predicted share price climb to $650. This strike price enables you to buy the stock at $620 any time before the option expires. The price you pay for the option is known as its ‘premium’.

If Tesla’s share price rises above $620, as you predicted, you can exercise the option and buy that market at a lower price. If, however, the share price remains below the strike price, you’d choose not to exercise it, and simply let it expire. In this case, your loss is limited to your premium.

Because share prices are volatile, an option’s premium will fluctuate as the probability of that option being profitable on or before its expiry date changes.

When you trade stock options with us, you’ll use spread bets and CFDs to speculate on movements in an option’s premium, without ever owning the option itself. This means you could get certain tax benefits,¹ you don’t have to take delivery of physical assets, and you’ll have more control over your position size.

It’s important to bear in mind that spread bets and CFDs are leveraged. So, profits will be magnified – as will your losses. It also increases your trading risk, which means an effective risk management strategy is important. We explore how your risks vary between buying and selling options in more detail below.

Five key characteristics of stock options

A stock options contract has five distinct elements that define it:

1. Strike price
   This is the price at which the underlying shares you’re trading on will be bought or sold if the contract is exercised, regardless of the stock’s market price at the time. The strike can be equal to, above or below the shares’ market price.
2. Contract size
   One stock option contract frequently represents 100 shares of the underlying company shares. However, contract sizes may differ, for example between companies, exchanges or locations.
3. Expiry date
   This is the date on which the contract ceases to be valid. With us, you can exercise options on or before this day – these are also known as ‘American-styled options’. European-styled options, on the other hand, can only be exercised on the expiry date itself.
4. Type of option
   There are two types of options, known as calls and puts.
   • A call gives you as the holder the right to buy shares at the option’s stated strike price. If the strike is below the stock’s current market price, the option holder is ‘in the money’, meaning you’re essentially buying the shares at a discount. If the strike is above the market price at expiry, the option becomes worthless
   • A put is the opposite, instead giving you the right to sell shares at the stated strike price. This time, you’re ‘in the money’ if the strike is above the current market price, meaning you’re essentially selling the shares for a profit. If the strike is below the market price at expiry, the option is rendered worthless
5. Type of settlement
   When trading stock options with us, all positions are cash settled. This means no actual shares change hands – instead, the difference between the stock’s price and the strike price is settled in a cash payment.
   
   However, stock options contracts are also often physically settled. This means that real company shares are either bought or sold, and then delivered.

How do share options work?

Share options work by fixing a strike price at which an agreed-upon number of shares can be either bought or sold on or before their expiry date. You can choose to buy a share option and become the option’s holder; or you can sell an option for a premium. Each comes with different advantages and risks.

Buying a share option

Here, you’ll purchase a call or put and pay a premium to the option’s seller. The main advantage of buying a share option in either of these is limited risk, as your risk is limited to the premium amount. You’d lose your whole premium if the strike price rises above the market price (for a call) or falls below the market price (for a put) at expiry.

However, it’s important to remember that you can also lose part of your premium if your option’s strike price doesn’t exceed the market level enough to cover your initial outlay.

• You’ll buy a call if you think the share price will rise. You’ll only earn a profit if the difference between the share’s market level and the strike price is greater than your premium amount. For example, if your strike was $100 and your premium was $10, you’d only start earning a profit when the market level is higher than $110. If the market level is $105, the strike price has been exceeded, but not by enough to cover your initial outlay, so you’d incur a $5 loss on the trade
• You’ll buy a put option if you think the share price will fall. You’ll only earn a profit if the difference between the strike price and the share’s market level is greater than your premium amount. For example, if your strike was $110 and your premium was $10, you’d only start earning a profit when the market level is lower than $100. If the market level is $105, for example, the strike price has been exceeded, but not by enough to cover your initial outlay, so you’d incur a $5 loss

Selling a share option

Selling share options often incurs greater risk than buying. This is because your potential losses could be substantial if the stock’s market price moves a large distance from the strike. Your maximum potential upside is the premium you could earn from the option.

• You’ll sell a call if you think the share price will fall. Here, your risk is technically unlimited. This is because there’s theoretically no ceiling to what the share price could rise to, which you’re obligated to buy
• You’ll sell a put if you think the share price will rise. Your risk is limited to the value of the strike price, multiplied by your position size. So, say the strike is $100 and the share becomes worthless ($0), your loss is limited to $100. However, if the market level rises to above the strike price, you keep the entire the premium. If, however, you earned $10 from the premium, but the market level is at $95, you’d lose $5 of your premium

Share options: looking at the risks and rewards

Ways to trade stock options in the UK

There are three ways to take a position on stock options in the UK:

1. Spread betting on stock options

A spread bet on a stock option tracks the price of an underlying listed option, where you’ll bet per point on the movement of the price being traded on. For example, using a spread bet to buy a call option at £10 per point of price movement will earn you £10 for every point that the option’s value increases.

In the UK, you can spread bet on options alongside thousands of other markets, and there’s no tax to pay on your profits.¹

Spread betting is the only way to trade stock options tax-free, and spread bets give you greater control over your position size than buying or selling listed options through a broker.

All spread bets are cash settled, so you never have to deliver, or take delivery of, the actual underlying shares.

2. CFD trading on stock options

As with spread bets, when you trade stock options with CFDs, your trade mirrors the underlying options market. The main difference is that, instead of betting per point as in spread betting, CFD options are traded in contracts that are worth a selected amount.

For example, if you buy a CFD on a call option worth $10 per point, the number of contracts you buy will multiply that amount. So, if you bought five contracts, you’d earn $50 per point the call option’s price moves beyond the strike, minus your margin.

It’s important to remember that trading with CFDs gives you less control of your deal size than spread betting does.

CFDs are subject to capital gains tax (CGT), though losses can be offset from profits.² This ability to offset losses from profits for CGT purposes means that CFDs can be used to hedge against the depreciation of stocks in your existing portfolio.

All CFD trades are cash settled, just like spread bets. So, you’ll never have to deliver, or take delivery of, actual shares.

3. Trade options with a broker

Like shares, listed stock options are traded on registered exchanges. You need to meet certain requirements to buy and sell options directly on an exchange, so most UK retail traders will do so via a broker.

When you trade with an options broker, you deal on their platform – usually paying commission on each trade – and they execute the order on the actual exchange on your behalf. However, we do not offer this.

Unlike trading with spread bets or CFDs, when you buy or sell through a broker, you may have to deliver, or take delivery of, actual shares.

Why trade share options?

• Options are leveraged products. When buying an option, you’re essentially gaining exposure to the full value of the market for a premium that’s a fraction of your total position size. This premium is also your total risk
• When buying an option, you set your own level of leverage and maximum risk when choosing the premium you’re willing to pay
• Stock options can be used to hedge against losses in an existing share portfolio. For example, you can buy a put if you expect the value of a share to decrease – this’ll enable you to sell the market at a higher price if the share depreciates. Alternatively, you can sell a call to short the market, but this incurs significant risk – which is potentially unlimited

Understand how stock options work

Options are particularly complex instruments. Before trading with options, ensure that you understand how they work, how they’re priced, and what risks you face as a buyer or seller.

Additionally, make sure to research the stock you want to take a view on, and determine your predicted price level. This’ll set your strike price and premium.

Find out more about options, and see the difference between options and futures.

Choose whether to trade using spread bets or CFDs

With us, you’ll trade stock options via either spread bets or CFDs. As CFDs are traded in contracts, you’ll deal in standardised lots of 100 shares per CFD, which essentially functions much like trading listed options does. However, you’ll also be exempt from stamp duty in the UK.²

Spread bets are traded per point of price movement, which enables for more control over your position sizes, so you can potentially trade smaller amounts if you’d like to. Spread betting is completely tax free, too.⁵

Create a trading account

Open a live spread betting or CFD account via our online form to trade on our award-winning platform,⁴ with no obligation to add funds until you want to place a trade.

You’ll get access to over 17,000+ popular markets, plus round-the-clock phone support and lower minimum deal sizes for your first month. Note that not all markets are available to options traders.

Alternatively, you can practise trading first in our risk-free demo account.

Decide whether to buy or sell calls or puts

You can go long (which you’ll do if you think a stock’s share price will rise) in two ways – buying a call option or selling a put option. Likewise, you can go short (which you’ll do if you think the stock price will drop) in two ways – buying a put or selling a call. Each type of option has its own advantages and risks. If you sold a call, your profit potential is limited to the option’s premium amount. However, your loss potential is theoretically unlimited, so be sure to have a risk management strategy in place.

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