There are multiple techniques available for trading in the options market in the UK, each with its benefits and downsides. Let’s take a moment to go through some of these techniques to decide which will work best for your situation when you start trading.
The Short Strangle
The first technique is known as ‘short strangle’. This involves selling an out-of-the-money put option while simultaneously selling an out-of-the-money call option. For example, if the price of the underlying asset is currently at £60, you would sell options that expire in one month with a strike price of £55 for say 35 pence and simultaneously sell options that expire in the same month with a strike price of £70 for 10 pence.
A short strangle can be considered taking out insurance on an option trade because it will lose money unless the bottom line is hit. If this sounds like something that might work for you, then there are a few things to watch out for:
This technique only works well when volatility is low, so you need to ensure that your broker offers high volumes to get reasonable prices on short strangles. Use Google Finance or Yahoo finance to look up historical volatility and compare it to the VIX.
This strategy works best when your broker charges a fixed commission per trade rather than a percentage. This is because you will be trading both sides of the strangle, and so each position will be double the size of most other trades, making them more costly if your broker charges a percentage fee on every deal.
If you employ this technique, it is essential to remember that there are two strike prices involved for each option which means that you’re effectively covering all possibilities. As such, your stop loss needs to be placed well away from the breakeven point.
The Butterfly Spread
Our following technique is called ‘butterfly spread’. The butterfly spread can be used in commodities or shares and involves buying one call option with a low strike price, selling one middle option and buying another higher strike price option.
An example would be if the stock is trading at $50, you would buy the 50 strikes for, say, 25 pence per share (call options), sell the 55 strikes for say 15 pence each (put options) and buy the 60 strikes for 10pence each. The spread between these three premiums will give you your ‘wings’. e.g. If you paid £1 for wings, then you could lose 100p on either side of 45 (i.e., 5/+10) but only gain £4 where the market moves outside this range
Butterflies work well in up or down trending markets because they have a limited loss and a fixed profit, which means that they are not as risky as other spread techniques. On the other hand, this technique is not suited to sideways moving markets because you don’t have unlimited profit potential.
The Credit Spread
Credit spreads involve selling a lower strike price option closer to the money. You then use this premium to buy a higher strike price option further out of the money. For example, if the stock is trading at £50 per share, you would sell an option with a strike price of say 55 for 20 pence and use that premium to buy an option with a strike price of 60 for 40 pence. This technique ensures you always make money as long as the market doesn’t move too far away from your starting point.
So you want to get into trading but aren’t quite sure where to start. The options market in the UK provides an excellent opportunity for new traders because of its flexibility and low barrier to entry, with many brokers even allowing trading in mini contracts. We recommend using a reputable online broker from Saxo Bank and trade on their demo account before investing your money if you are a new investor.