Find out everything you need to know to start options trading: including which markets you can trade, what moves options prices, and how you can get started.
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When the underlying market is closer to the strike price of an option, it is more likely to hit the strike price and carry on moving. So an option on AUD/USD with a strike price that’s 50 points away from the current level of the market will be less likely to become profitable than one with a strike price that’s 15 points away, and therefore should have a lower premium.
The longer an option has before it expires, the more time the underlying market has to hit the strike price. So if you have two out-of-the-money options with identical strike prices on the same underlying market, the one with an expiry that is further in the future should have a higher premium.
The more volatile an option’s underlying market is, the more likely it is that it will hit its strike price. So if a market sees a sudden uplift in volatility, options on it will tend to see a corresponding increase in their premiums.
Long calls and long puts are the simplest types of options trade. They involve buying an option, which makes you the holder. You’ll make a profit if the underlying market moves above (calls) or below (puts) the strike price by more than your premium, and the cost of the premium is also the maximum loss you can make from the trade.
If you own an asset and wish to protect yourself from any potential short-term losses, you can hedge using a long put option. This strategy is called a married put.
In a short call or a short put, you are taking the writer side of the trade. The simplest of these is a covered call position, where you sell a call option on an asset that you currently own. Then if the price of the asset that you own doesn’t exceed the strike price of the option you’ve sold, you can keep the premium as profit.
You can also write call options when you don’t own the underlying asset, which is known as an uncovered or naked call. However this is a risky strategy, as you may end up having to pay for the full cost of the shares in order to sell them at a loss to the holder.
You aren’t limited to trading a single option at a time. A straddle, for instance, involves simultaneously buying both a put and a call option on the same market, with the same strike price and expiry. By doing this you can profit from volatility, regardless of whether the underlying market moves up or down. But if no volatility occurs you’ll lose your premium.
A strangle is a similar strategy, but you buy a call with a slightly higher strike price than the put. This means that you need a larger price move to profit, but will typically pay less to open the trade because both options are purchased when out of the money.
And, of course, you can take the other side of both straddles and strangles – using short positions to profit from flat markets.
Spreads involve buying and selling options simultaneously. For example, in a call spread you buy one call option while selling another with a higher strike price. The difference between the two strike prices is your maximum profit, but selling the second option reduces your initial outlay.
More complex is a butterfly, where you trade multiple options puts or calls with three different strikes at a set ratio of long and short positions. In doing so, you can earn profits when volatility is low, without excessive risk. There are a few different types of butterfly strategy: such as the condor, iron butterfly and iron condor.