Listed options are securities traded on the London Stock Exchange. Listed options can be either American or European styles. You can exercise an American style option at any time up to and including the expiration date. However, you can only exercise a European-style option on the expiration date.
The price of an option is called the premium. The premium consists of two parts: intrinsic value and time value. Intrinsic value is the difference between the exercise price and the current market price of the underlying security. Time value is what remains of the premium after subtracting the intrinsic value.
When deciding whether or not to exercise an option, you need to consider three things: intrinsic value, time value, and the commission you would pay to exercise the option.
If the intrinsic value is more significant than the time value, it’s usually a good idea to exercise the option. If the time value is greater than the intrinsic value, it’s usually not a good idea to exercise the option. However, it is advised to always consult with your financial advisor before making any decisions.
How to trade listed options
Once you have an account and have funded it, you can start trading listed options.
Choose the underlying security you want to trade
There are several types of underlying securities available, so you need to choose one that fits your investment strategy. Examples of securities that are available include:
- Shares of individual companies
Determine if you want to buy or sell an option
If you want to buy an option, you need to decide what option you want to buy. Two types of options are available: call and put options. A call option gives the holder the entitlement to buy the underlying security at the exercise price. A put option gives the holder the entitlement to sell the underlying security at the exercise price.
Enter the exercise price and expiration date
The exercise price is when the underlying security can be bought or sold. The expiration date refers to when the option expires. You can find this information in the option contract.
Determine the order you want to place
You can choose between three orders: market order, limit order and stop-loss order. A market order is to buy or sell the underlying security at the current market price. A limit order is when you trade the underlying security at a specific price or better. A stop-loss order is when you sell the underlying security when it reaches a specific price.
Place your order
All that is left to do now is enter all relevant information into the brokerage’s trading platform. Then hit “submit”, and you will have placed your order.
What are the risks associated with trading listed options?
The option may expire valuelessly
An option may expire worthless if the underlying security doesn’t trade above the exercise price by the expiration date. It is called a “dead” or “out of the money” option.
You may exercise the option prematurely
Suppose the underlying security trades above the exercise price, the holder of a call option may choose to exercise their right to buy the security at the exercise price. If the holder of a put option chooses to exercise their right to sell, this is called being “assigned.” It can happen at any time up to and including the expiration date.
You may not get filled at your desired price
When you place an order, you may not get filled at your desired price. It can happen if there are not enough buyers or sellers at that price. You may also get filled at a different price than what you specified.
How to avoid these risks
Hedge your position
You can reduce the risk of an option expiring worthless by hedging your position. Meaning you are buying or selling the underlying security in addition to buying or selling the option.
Diversify your portfolio
You can reduce the risk of an option being exercised prematurely by diversifying your portfolio. Meaning you should invest in a variety of different underlying securities.
If you want to test your skills with listed options, sign up for a free trial here.