The listed options trading scene in the MENA (Middle East and North Africa) region is relatively small compared to other regions. However, it has been growing steadily in recent years, with more investors in the region seeking to diversify their investment portfolios and take advantage of the potential benefits of options trading. With improved financial literacy and trading infrastructure established in these countries, it has also become more convenient for traders to participate in listed options trading.

In this article, we want to look at what listed options trading is, how it works, and its appeal for investors. If you are interested in knowing more about trading these financial derivatives, read on.

What are listed options?

Listed options are financial contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. Listed options are standardised contracts, and trading takes place on organised exchanges such as the Chicago Board Options Exchange and the NYSE American Options exchange.

These exchanges act as clearinghouses for the options trades, which means that the exchange guarantees the performance of the contract. This reduces the risk of default by the counterparty, and it makes listed options an attractive option for many investors.

How do listed options work?

To trade listed options, the following steps usually take place:

Firstly, the buyer of the listed option pays a premium to the seller of the option. The premium is the price of which the option contract is bought, and it represents the cost of the right to buy or sell the underlying asset.

The options contract specifies the terms of the trade, including the underlying asset, the expiry date, and the strike price. The underlying asset is the financial instrument on which the option is based, such as a stock, bond, or commodity.

Call options give holders the right to buy an underlying asset at the strike price, while put options do the opposite – they allow holders to sell the underlying asset at the strike price. The strike price is the price at which the option can be exercised. If the price of the underlying asset is above the strike price for a call option, the holder can exercise it. If the price of the underlying asset is below the strike price for a put option, the holder can exercise it.

The expiry date is the date the contract expires. If the contract holder does not exercise the option by the expiry date, the contract becomes worthless. The trader then loses only the premium they paid for the contract and do not risk losing more capital beyond that.

An example of trading listed options

Let’s say an investor is interested in purchasing shares of ABC Company, which is currently trading at $100 per share. The investor is unsure whether the stock will continue to rise or fall in the near future and wants to limit their risk.

To hedge against potential losses, the investor decides to purchase put options on ABC Company. The put options have a strike price of $95 and the expiry date of one month. The premium for the put option is $2 per share.

By purchasing the put options, the investor gains the right to sell the shares of ABC Company at the strike price of $95, regardless of the current market price. If the stock price does indeed fall to or below $95 by the expiry date, the investor can exercise their put options and sell the shares at the higher strike price, which can help limit their losses.

On the other hand, if the stock price remains above $95 by the expiry date, the investor can simply choose not to exercise the option and the contract will expire worthlessly. This means that the investor loses the premium paid for the contract, but nothing else.

Why trade listed options?

The appeals of listed options are many, including the derivative’s flexibility, diversification availability, and the potential to generate income. People generally trade listed options to hedge against market volatility and speculate on financial market movements. It is also a great way for traders to diversify their portfolios and manage interest risk in some cases.

Hedge against market volatility

Options traders use options to hedge against market volatility and protect against potential losses. It is a risk management strategy that is popular with investors of intermediate and above experience and skill levels.

Investors who have exposure to commodities, such as oil or gold, may use options contracts to hedge against price volatility. For example, an investor who owns a portfolio of oil stocks can purchase options contracts that give them the right to sell oil at a predetermined price. If the price of oil falls, the investor can exercise the options to sell oil at the predetermined price, which can help limit their losses.

Potentially generate income

Options traders also use options contracts to speculate on markets and potentially generate income from market movements. For those who sell options, they can generate income through the sale of the premium, which depends on the size of the contract and the instrument speculated on.

The use of leverage

Options allows investors to gain exposure to an underlying asset for a fraction of the cost of purchasing an asset outright. This is because traders can use leverage when trading. However, leveraged trading with options can be a high-risk strategy that requires a thorough understanding of options contracts and their underlying assets. It is essential that traders carefully evaluate the potential risks and rewards before engaging in leveraged trading.

Managing interest rate risk

Options can be used to manage interest rate risk by hedging against changes in interest rates. For example, an investor who holds a portfolio of bonds can purchase put options on Treasury bonds to protect against an increase in interest rates, which can cause bond prices to fall. If the interest rates do increase, the investor simply exercises the put options to sell the Treasury bonds at the predetermined price, which can help limit their losses.

Diversify portfolios

Finally, options contracts can cover a wide variety of underlying assets, and they are a good method of diversifying investment portfolios and managing risk. This is because traders can speculate on stocks, bonds, commodities, currencies, and more instruments. For example, an investor who wants exposure to the gold market can purchase call options on a gold ETF, which gives them the right to buy the ETF at a predetermined price within a specified time period.

Final words

Options trading is a potentially lucrative way to trade, and it is enjoying a fast-growing popularity in the MENA region. For those who are looking to diversify their portfolio, potentially grow their capital, and hedge their existing positions, options contracts can indeed serve very great value. Yet it is essential to note that options trading can be complex and risky, so traders should carefully evaluate the potential risks and rewards before engaging in options trading. If you are unsure about how to trade options, it may also be a wise choice to consult with a financial advisor who can provide personalised advice based on your circumstances and investment goals.