Investing in listed options is a popular choice for traders, as it allows them to be more flexible and adaptable than other trading methods. Traders who choose this trading method typically do not pay commissions or fees to brokers since these transactions are conducted through an electronic network like the London Stock Exchange (LSE). It makes them more accessible and suited for short term investments and opportunities.
Risks
However, we would like to highlight the risks involved when choosing this kind of stock trading. The main risk is that they are not covered by the Financial Ombudsman Service nor by Financial Services Compensation Scheme, which covers traditional stocks.
Other factors that you need to watch out for are not selling your option if you have to, as it is a binding contract and waiting for your option’s expiry date before you can start selling. It means that buying an option is riskier than holding the actual stock.
Listed options also allow traders to hedge their investments and reduce their exposure to risks which helps them limit losses and maximise gains. There are, however, hidden costs and commissions associated with hedging, so traders need to consider these extra costs.
A listed option is trading on a public exchange in the stock market such as the London Stock Exchange, NASDAQ or NYSE Euronext. In general, investors purchase these options from banks and financial institutions – this means that they do not have to make deals with other people or traders directly.
The nature of listed options allows them to be flexible and adaptable compared to other trading methods. The main advantage of these types of transactions is that they are done electronically through a network like LSE, making them more accessible and faster for short term investments and opportunities.
Do I need a broker to trade listed options in the UK?
The answer to this question is no. You don’t need a brokerage to trade options. Anyone can trade options – if they choose not to use a broker, they will carry the entire counterparty risk themselves.
For instance, in the case of an index option (such as Vodafone), many counterparties could payout when you exercise the contract against them at expiry. Using an exchange is usually preferable, though: it’s more efficient and reduces costs for both buyers and sellers. It also protects in some circumstances, such as where one side defaults before settlement or fails to set off their positions on an opposite transaction that occurs within the same day.
Despite what some brokers might claim, there isn’t a legal requirement for you to use their service if you don’t want to. For example, they can’t stop you from simply opening an account with another brokerage; it’s your money, and the stock exchanges are open to anyone who wants to trade. However, using a broker may be helpful or necessary in some cases – even when trading listed options.
It is possible (and convenient) to buy and sell put and call options on shares by dealing through your bank or broker, even though this transaction takes place on an exchange without the direct involvement of that institution. If you bank with Barclays, then the easiest way for them to carry out instructions would probably be via Barclays Stockbrokers who act as agents for their customers when carrying out transactions on the LSE for them.
However, if you don’t bank with Barclays, it is even easier: you need to phone your broker and give him the details of your trade, and he will do all the work for you. Some brokers specialise in listed options such as Interactive Brokers, OptionsXpress, and Saxo Bank can carry out these orders on desks at LSE.
Suppose you use a discount broker such as Hargreaves Lansdown or Charles Stanley. In that case, they also offer an optional service which means that you can deal directly with them without having to go via a different brokerage – but if you do this, remember that they only offer limited types of instruments.
Pros and cons of listed options
Pros
- Accessibility
- There are no commission or fees for brokers·
- Unlimited investment possibilities
- Hedging available
Cons
- Not covered by the FOS and Financial Services Compensation Scheme – These two organisations protect investors of traditional stocks. However, they do not provide coverage for listed options. Furthermore, compensation schemes only compensate up to £50,000 or $100,000, depending on your location and currency.
- Expensive hidden costs associated with hedging – A large part of traders’ profits may get eaten up by these commissions and fees, which is why you must take note of all the costs related to hedging before making any decisions.
