Options trading is becoming more and more popular with UK traders. The Financial Conduct Authority (FCA) reports that the number of individual options traders has almost doubled in the last five years. However, with this thriving industry come some problems that are common across all new traders.
Here are seven key things you should be aware of when trading options in the UK
7 Avoidable common options trading problems in the UK
1. Expiry time management
Traders can buy options contracts on many different kinds of underlying assets; stocks, indices etc. These contracts expire as soon as their expiry time has passed or at a specific date and time before this point which is predetermined by the trader who made the contract.
Some methods for managing expiry times include: manually closing out your position before it expires, using an automatic ‘trade to close’ function within your platform or using ‘American style’ options which expire on the day of purchase if they are not closed beforehand.
2. Be careful with leverage
Leverage is great when it works for you, but it can be dangerous too. If you think that strong downward or upward movements are guaranteed, be mindful of the brokerage costs and account fees, which could wipe out any gains if the market does anything other than expected.
3. Don’t use stop losses
Don’t use stop losses unless you know exactly what price something will trade at before it trades, and there’s no way to guarantee that using a stop-loss order will achieve whatever goal you have in mind about exits. Even traders who do their best to time entries often let profits run- it’s letting them run to an exit strategy which can be difficult.
4. Don’t be afraid to take a loss early
f you think the trade isn’t going to work out, don’t hesitate to cut your losses and move on. Waiting for things to get back ‘to where you were’ only makes sense if you have no other way of making money in the market.
5. Be mindful of volatility
This one is relevant when trading European options, which can’t be exercised before expiry (one of the reasons I like trading them!) What often happens is that a trade will work well when volatility is high but then fall apart fast if it falls too much. It doesn’t have to be this way- there are ways to manage positions so that they either benefit from higher volatility, don’t get hurt by a lower range or both.
6. Avoid taking too much risk
Trading at high volumes with money you cannot afford to lose can be very dangerous. It can lead to significant losses that become even more difficult to recover from, especially when starting. It is best to treat trading as a business and account for your activity within this structure. A helpful way of doing this is by looking at your potential profit or loss per trade. Although some traders prefer not to do this, quantifying how much each trade could make or cost enables you to allow other factors such as time, volatility, liquidity etc., to influence your strategy.
7. Market timing and overtrading
Market timing is another problem that is common across all types of traders. This issue relates to over trading, where you take more risk than necessary to make quick returns. It can be challenging to avoid this when the markets are moving quickly, but it does pay off in the long run if you use a fixed stop loss or plan your trades in advance
The UK’s Financial Conduct Authority (FCA) reports that these problems are common among UK traders no matter their experience level. Fortunately, they are easy to avoid by following some guidelines and maintaining discipline when trading options. We recommend using a reputable online broker from Saxo Bank and trading on a demo account. For more information, visit their website here.