What are options and how do you trade them?

What are options?

Options are contracts that let you trade on the future value of a market, giving you the right – but not the obligation – to trade the market at a set price on or before a set date. The most common type is often called a ‘vanilla option’ because it has no additional features.

For example, you expected the price of US crude oil to rise from €50 to €60 a barrel over the next few weeks. You decide to buy a call option that gives you the right to buy the market at €55 a barrel at any time within the next month. The price you pay to buy the option is known as the premium.

If US crude oil rises above €55 (the strike price) before your option expires, you’ll be able to buy the market at a discount. But if it stays below €55, you don’t need to exercise your right and can simply let the option expire. In this scenario, all you’ll have lost is the premium you paid to open your position.

We offer two types of options – vanilla options and barriers:

• Our vanilla options are similar in structure to traditional options, and are available for a variety of forex pairs, indices and commodities
• Our barrier options allow you to trade on both rising and falling markets, and use a knock-out level set by you to cap your maximum risk

The essentials of options trading

Take a look at the key types, features and uses of options:

1. Call options
2. Put options
3. Leverage
4. Hedging

What are call options?

A call option gives the holder of the option contract the right, but not the obligation, to buy an underlying asset at a predetermined price – called the strike price – on a set expiry date. Depending on the style of the contract, it may also be exercised before the expiry. If the terms so specify, call options can be cash settled, meaning that no physical assets need to be exchanged. You can buy or sell call options.

Buying a call option gives you the right to buy an underlying market at the strike price. The more the market value increases, the more profit you can make.

Selling a call option will obligate you to sell the market at the strike price if the option is executed by the buyer on or before expiry.

What are put options?

A put option gives the holder of the option contract the right, but not the obligation, to sell an underlying asset at a predetermined price – called the strike price – on a set expiry date. Depending on the style of the contract, it may also be exercised before the expiry. If the terms so specify, put options can be cash settled, meaning that no physical assets need to be exchanged. You can buy or sell put options.

Buying a put option gives you the right to sell a market at the strike price on or before a set date. The more the market value decreases, the more profit you make.

Selling a put option will obligate you to buy the market at the strike price if the option is executed by the buyer on or before expiry.

When trading on our vanilla options and barriers, you speculate exclusively on price movements in an underlying options market and never take delivery of any physical assets. Our offerings are always cash-settled. As with all options, however, you still maintain the right, but not the obligation, to exercise your option.

What is leverage in options trading?

Vanilla options and barriers are leveraged products. They allow you to speculate on the movement of a market without ever owning the underlying asset. This means your profits can be magnified – as can your losses.

For traders looking for increased leverage, options trading is an attractive choice. By choosing your strike and trade size you get greater control over your leverage than when trading spot markets.

When buying call or put options, your risk is always limited to the premium you paid to open the position. However, it’s important to remember that when selling call or put options, your risk is potentially unlimited.

How can you hedge with options?

Hedging with options allows traders to limit potential losses on other positions they might have open.

Say you owned stock in a company, but were worried that its price might fall in the near future. You could buy a put option on your stock with a strike price close to its current level. If your stock’s price is down below the strike at your option’s expiry, your losses are limited by the option’s gains. If your stock’s price increases, then you’ve only lost the cost of buying the option in the first place.

How to trade options in Ireland

1. Understand options trading terminology
2. Identify what determines an option’s price
3. Learn about ‘the Greeks’ in options trading
4. Pick an options trading strategy
5. Choose a market to trade options on
6. Determine the timeframe during which the market is likely to move
7. Decide whether to buy or sell, and place your trade
8. Monitor your position

Understand options trading terminology

Traders use some specific terminology when talking about options. Here’s a rundown of some of the key terms:

• Holders and writers: the buyer of an option is known as the holder, while the seller is known as the writer. For a call, the holder has the right to buy the underlying market from the writer. For a put, the holder has the right to sell the underlying market to the writer
• Premium: the fee paid by the holder to the writer for the option. When trading CFDs on options with us, you’ll pay a margin that works in a similar way to the premium
• Strike price: the price at which the holder can buy (calls) or sell (puts) the underlying market on the option’s expiry
• Expiration date/expiry: the date on which the options contract terminates
• In the money: when the underlying market’s price is above the strike (for a call) or below the strike (for a put), the option is said to be ‘in the money’ – meaning that if the holder exercised the option, they’d be able to trade at a better price than the current market price
• Out of the money: when the underlying market’s price is below the strike (for a call) or above the strike (for a put), the option is said to be ‘out of the money’. If an option is out of the money at expiry, exercising the option will incur a loss
• At the money: when the underlying market’s price is equal to the strike, or very close to being equal to the strike, the option is referred to as ‘at the money’

Identify what determines an option’s price

There are three main factors affecting the options’ price (premium, or margin. All these factors work on the same principle: the more likely it is that the underlying market price will be above (calls) or below (puts) an option’s strike price at its expiry, the higher its value will be.

• Level of the underlying market
  The further below the underlying a call option's strike is, or the higher above the underlying a put option's strike is, the higher their premiums are likely to be as they are ‘in the money’ – there's more chance of them expiring with value.
• Time to expiry
  The longer an option has before it expires, the more time the underlying market has to pass the strike price – so an out-of-the-money option will tend to lose value as it nears its expiration date and there’s less chance of it expiring profitably.
• Volatility of the underlying market
  The more volatile an option’s underlying market is, the more likely it is that it will pass the strike price. So volatility tends to increase an option’s premium.

Learn about the Greeks in options trading

The Greeks are measures of the individual risks associated with trading options, each named after a Greek symbol. Understanding how they work can help you calculate the risk involved with each of the variables that affect option prices.

• Delta
  Delta is a measure of how sensitive an option’s price is to the movement of the underlying market. Assuming all other variables stay the same, you can use delta to work out how much impact market movement will have on the value of your option.
• Gamma
  A derivative of delta, gamma measures how much an option’s delta moves for every point of movement in the underlying market.
• Theta
  Theta measures how much an option’s price decays over time. A high theta indicates that the option is close to the expiration date; the closer the option is to expiry, the quicker the time value decays.
• Vega
  An option’s vega measures its sensitivity to volatility in the underlying market, or how much the option’s value will change for every 1% change in volatility.
• Rho
  Rho indicates how much interest rate changes will move an option’s price. If the option’s price will go up as a result of interest rate changes, its rho will be positive. If the option’s price will go down, its rho will be negative.

Pick an options trading strategy

There are numerous strategies you can use to achieve different results when you’re trading options. Popular options trading strategies include:

Choose a market to trade options on

You can trade options on a huge number of markets with us.

• Forex – including majors like EUR/USD, GBP/USD, USD/CHF and EUR/GBP
• Shares – our barrier options include a selection of leading US and European shares
• Stock indices – such as the DAX 30, CAC 40, Italy 40, IBEX 35, FTSE 100, Wall Street
• Commodities – including gold, silver and oil

Determine the time frame during which the market is likely to move

Depending on the kind of trade you’re making, you can choose between daily, weekly, monthly or quarterly options to suit your goals.

Use daily and weekly options if you want to take positions on markets quickly, but with greater control over your leverage than when trading other products – such as trading CFDs – on spot markets.

If you’re looking at longer-term market movement, monthly and quarterly options mean you can take positions up to three quarters before expiry – plus you’ll know your risk upfront and usually save on funding charges.

Decide whether to buy or sell, and place your trade

Once you’ve chosen your market and timeframe, you need to determine whether you want to trade using our vanilla options or barriers.

If you settle on vanilla options, you have to decide whether to buy or sell a call or put option on the market you’re trading. The type of option you trade, and whether you buy or sell, will depend on whether you want to speculate on the market rising or falling. Remember that buying options is limited-risk, while selling is not.

If you decide on barriers, choose a knock-out level that suits your preferred levels of risk and leverage, and open a position with either a call or put barrier – depending on the direction in which you think the market will move.

Monitor your position

Once you’ve opened a position, you need to keep an eye on market movements and your potential profits or losses.

For vanilla options, if the option is in the money, you may wish to close it before the expiry date and lock-in your current revenue. When you close your position depends on your interpretation of market conditions and your appetite for risk.

For barrier options, if the market moves beyond your knock-out level, your position will automatically terminate and you’ll lose the premium paid to open the position. If the market price never hits your knock-out, you can close at any time to realise your current profit or loss.

Ways to trade options

We offer two types of options that can be used for trading:

1. Trade vanilla options
Our vanilla options are contracts that are extremely similar to the options described on this page. When trading with us, however, you’ll trade exclusively on the price movements of an underlying options market and will never have to take delivery of, or deliver on, any asset.

Create an account to trade our vanilla options

2. Trade barrier options
Barriers, like vanilla options, are based on an underlying options market. They track the underlying market one-for-one and their price is derived directly from the difference between the current market price and the knock-out level, plus fees. While both barrier calls and puts are limited-risk, all markets can be volatile and losses can accrue quickly.

Unlike vanilla options, you can’t ‘write’ a barrier – instead, you open a position with a put if you think the market will fall, and with a call if you think the market will rise.

Create an account to trade our barriers

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