Trading in Options

The current volatility in both the equity and commodity markets can make it quite daunting to hold your nerve over the long term.

Perhaps you think the Dow Jones is due a further fall before the end of the year, but are worried about being stopped out on sharp intraday rises? Or you might like to take a macro view on the price of a commodity, but are concerned by the magnitude of some of the daily gyrations? Spread betting on an options rather than a futures contract can provide your required exposure while controlling the potential downside.

How does spread betting on options work?

An option is a financial instrument that gives the holder the right to buy or sell an underlying instrument at a previously agreed price (known as the ‘strike’ of the option). The price of an option in trading reflects the potential expiry value of the option, and depends upon factors such as the length of time the option is valid for (generally, the more time on offer, the more expensive the option) and the current level of the underlying market in relation to the strike.

It is important to note that when you bet on an option with IG Index the option will not be exercised on expiry. Instead the bet will settle at its expiry value, as follows:

• For a call option the expiry value is the level of the underlying minus the strike price
• For a put option the expiry value is the strike price minus the level of the underlying
• In neither case can the expiry value be less than zero

If you believe a market is heading lower, buying a ’put‘ option can give you a limited risk exposure to a downwards move. If you think a market is going higher, buying a ’call‘ option can give you a limited risk exposure to an upwards move. The price of any option will obviously vary continuously as the underlying market moves, enabling you to trade out of a position if desired before expiry.

A further potential advantage of spread betting on an option is the increased degree of leverage you can achieve. This is because, when you go long of our option price, the most you can lose is the opening price multiplied by your stake. Hence this is the total deposit required to open your position. By contrast, the margin requirement to open a position on a futures contract will normally be higher, as your risk is not protected.

IG Index offers an unrivalled array of options products around the clock, with daily, monthly and quarterly markets on all the major stock indices, currencies and commodities. Plus spread betting on share options, covering the leading UK and US equities.

In addition to the thousands of prices available online, it may also be possible to trade on further, not listed, strikes over the telephone. Call your dealer for more information.

The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.

Updated: 26/11/07