The greater the investor's understanding of traded options, the greater the chance of trading profitably. Good educational material is available from better book shops. Lists of other reading materials and information on private investor seminars are available from the Equity Products Department, Liffe, Cannon Bridge, London EC4R 3XX, and Wise Speke, the stockbrokers, can also provide investors with information on traded option strategies, along with a sample of its research.
Before entering into any trade, an investor must have a clear idea of what he is hoping to achieve, whether the options are being used for speculation, hedging against loss or for portfolio enhancement.
The trading plan, once devised, should be followed strictly. Included in the trading plan should be the market or share expectations, at what level to take a profit and at what level to place a stop-loss. With a maximum life of nine months, traded options are a wasting asset - so if a position starts to move against you, it is often better to close out the position and accept a small loss.
Newcomers to the options market should first conduct a number of ghost or dummy trades before putting money into the derivatives market. This will allow investors to gain a 'feel' for the market and the validity of their expectations and the reasoning behind them.
If a small move is expected in the price of the underlying shares, an in-the-money option, which is likely to move penny for penny with the share price, should be selected.
If a larger move is expected, an at-the-money or possibly a slightly out-of-the-money option should be used. But, in general, an out-of-the-money option should only be used if a large movement - in a short period of time - is expected.
It is also generally recommended that no more than 10 per cent of an investor's total amount available for investment should be used for speculating in traded options.
This fund should be divided into 10 units, with no more than two units being invested in any one option. As and when any profits are made, a proportion may be used to increase the size of the units. If any losses are incurred, the units can be recalculated, thus reducing exposure to the market.
The options market is so fast-moving that it is vital to keep as up to date with prices as possible. Equity and index option prices are quoted on Ceefax (BBC 2) and updated several times a day. However, prices can move between updates. Options clients of some stockbrokers can be in touch with the options desk several times a day if they have an open position. Closing prices are available from quality newspapers such as the Independent.
For a free introductory pack to traded options, contact David Ford or James Butcher at Wise Speke, 071 617 2900.Reuse content