How options trading has evolved for the masses

How options trading has evolved for the masses

Over the last few years, the practice of options trading has grown substantially. This growth has coincided with a series of unpredictable political and social events, which have caused high levels of volatility across currency and commodities markets. Brexit, the election of Donald Trump in the US, and now the ongoing global pandemic, have led to prices and exchange rates changing frequently and more dramatically.

Traders are keen to capitalise on the significant rewards on offer here, but they must also stay aware of the risks. It is the need to balance these two that has led many to discover the merits of options trading.

We have seen periods of volatility before, of course, and options trading has been around for some time. The difference today is that these trends come alongside a transformative leap in trading technology. So, what exactly is options trading? How can it be used to trade safely? And how is technology opening it to a wider audience?

Options: The basics

In simple terms, options trading is the buying and selling of financial contracts, or options, that allow, but do not require, the owner to buy or sell an underlying asset at a certain price on a defined future date.

You can either buy a “call” option, which gives you the right to buy an asset, or a “put” option, which gives you the right to sell an asset.  Alternatively, you can sell these options to another trader.

A trader who anticipates that the pound will weaken against the US dollar over the next month, can purchase a put option on the GBP/USD exchange rate, enabling him to sell pounds and buy US dollars at the current market price and with an expiration date in 30 days. If the trader’s convictions are correct and the dollar gains against the pound, he can exercise the option and secure a profit from selling pounds at the higher rate.

This approach represents a more powerful and flexible way for traders to express their market views compared to spot trading.

The power here comes from the ability to combine buying and selling different types of options into a variety of strategies. These allow traders to match their portfolio risk to their precise market views (for example, GBP/USD will rise, but by no more than 20pips), while also being able to offer precise hedging tools with closely defined risk.

Trading with options can also be significantly less risky for investors when compared to trading the underlying instrument, as the maximum potential loss when buying options is the premium to buy the options in the first place.

Compared to spot trading, where investors can be exposed to much larger losses due to the symmetric risk of such trades, options put traders in a much better position to control their exposures, while keeping the door open to high-percentage returns.

Why options trading is growing in popularity

Although options trading has been on the scene for a very long time, it is only within the last few years that it has been available for the mass markets and we are seeing a significant rise in its popularity.

Before the advancements over the last decade, options were traded almost exclusively by institutional investors, large companies, and high-net-worth individuals, as opening a trading account at an established bank requires significant capital.

The typical options trading experience has not always been user-friendly, characterised by screens packed with cell after cell of flashing numbers, leaving traders to determine patterns based on their own calculations.

Between the need to chart a course through these screens and to having precise expectations for market movements, options trading was a practice largely left to the experts.

However, in the last few years, options trading has received an overhaul from fintech companies that have stepped in to take advantage of rapid technological progress.

The practice of options trading has been opened to a new and wider market by these companies: now anyone with as little as £1,000 to invest can start using options as part of their strategies.

Fintech companies have also designed new and improved desktop platforms that are easily understood and navigated, as well as new mobile platforms, both of which have ensured accounts are more convenient to open, access, and manage.

Online platforms have also taken away many of the headaches of traditional options trading through dedicated features that offer all the information needed to underpin a trade, automatically make any necessary calculations to clearly lay out the stakes, and provide vivid and easily comprehensible visualisations of how a trade might play out, including potential profits and losses.

These interactive interfaces even extend to offering clear explanations of different strategies and the situations they are useful in, as well as a simplified means of executing each of them.

The rise of online trading platforms has transformed the face of options trading, making the execution and understanding of the stakes considerably simpler than before.

Traders of all kinds are now well-positioned to execute a strategy, or a series of strategies, to match their market views and maximise their profits. As traders continue to navigate ongoing volatility, this could not have come at a better time.

Originally posted on finextra.com