What is the downside when buying an option?

[robinsmithesq]

Hi, If I buy an option on the IG platform, is the downside just limited to the fixed premium paid for the option in some way like a real world option or does the buy just track the price of the underlying option price and therefore the the PnL will move like any other spreadbetting instrument?

[Ian_944]

The "fixed premium" paid and "tracking the price of the option" are effectively one and the same thing. 

For example, take the example of paying £5 to buy a call option on Instrument X:

If you trade on the the actual option market, you pay £5 to buy the call. If at expiry the option finishes out of the money you lose £5.  If the option expires in the money, you take delivery of Instrument X which typically will have a value very close to the value of the option at the moment of expiry.

If you trade a spreadbet on an option on IG, you still pay £5 to establish the position (technically you pay a bit more because IG add their margin to the price of the option). If at expiry the option finishes out of the money, you lose that £5. If the option expires in the money you are paid the value of the option at expiry but do not take delivery of Instrument X. Again the value of the option at expiry will usually be very close to the value of the delivery of Instrument X. 

Both on the actual market and the spreadbet market, the value of the option (and in effect your MTM PnL) will fluctuate based on movements in the price of Instrument X, volatility, theta, etc.

Ian

 

 

 

Edited May 5, 2020 by Ian_944

[Guest]

downside limited to:

premium paid
counterparty risk - hopefully a long shot.
funding charges - hopefully a longer shot / lets not encourage the pass through of funding cost of house delta hedges to us.