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Banking and Finance

What are listed options?

Listed options – also known as ‘exchange traded options’, are options contracts which trade on a centralised exchange. As standardised contacts, they are guaranteed and backed up by a clearing house that ensures all terms of the options contract are followed by both parties.

Listen options are mainly popular because of the security offered by the clearinghouse guarantee. Their pricing is a complex affair, and involves multiple measures known as ‘the greeks’ – these include the change in option price as it reaches expiry (theta), the change in price in relation to the underlying security’s price (delta), the change in delta in relation to the underlying security’s price (gamma), and relation to changes in the risk free rate (rho).

It can all become quite confusing. Most retail investors have only a surface level understanding of these concepts, if at all, and though options are normally unprofitable for retail investors some do still make money without this knowledge.

Who trades listed options?

Listed options are used by professional investors at banks, corporate clients, and financial institutions. Increasingly, retail investors trade options for profit. This is known as speculation.

Most business-owners are more interested in using options as hedges than speculation. However, the line between the two can be blurred, and both involve ‘taking a view’ on the markets. Businesses with foreign exchange or interest rate risks are particularly keen on options. Banks and brokerage firms normally offer a wide range of options. Check with yours to see what contracts and underlying assets are available.

How can listed options impact my business?

Let’s say you work for a manufacturer of car parts. You know if there is a major downturn in the auto sector your business will suffer. One way of protecting from this would be to buy deep out-of-the money put options on car stocks. That was if the sector collapses, your profits from these out-of-the-money options will provide you with a cash buffer to protect your operations.

This is a form of hedging for your business. Additionally, if the price of a commodity can impact your business, you could use futures or other products to lock in current prices. There are several costs associated with this. Firstly, fees to any brokers, accountants or advisers who develop and execute your hedging strategy. Secondly, the cost of the options contract itself, which will see no return if the expected downturn doesn’t occur, needs to be considered.

Many businesses do not bother hedging in this fashion, either because they don’t know how to or don’t care to. It will act as an added cost to your normal business operations, but may reap dividends in the event of a downturn. Speak to your broker or financial advisor today to find out more.

What about retail investors?

Despite the rapid growth of the retail options sector, retail speculators remain a small part of the overall market. The majority of volumes go to major corporate and institutional firms looking to hedge risks, or make a market in options. Options providers need to then hedge their own risks, creating more demand for options. All of this is very profitable for institutional traders.

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