Option Investing Info
For those seeking a more diverse investment portfolio, the option offers a great deal of allure. The popularity of the option lies in its versatility, as options enable you to adjust your position according to situations as they arise. Ultimately, for the investor, options can be as speculative or as conservative as you like them to be. Versatility never comes without risk when it comes to trading and investments, and option investing can be extremely risky. Often when trading options, investors are given a disclaimer such as:
“Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carries substantial risk of loss. Only invest with risk capital.“
What Are Options?
An option is a contract that gives you, the buyer, the right (but not the obligations) to purchase or sell off an underlying asset at a specific price on or before the determined date. Like stocks and bonds, options are a security. They are also considered to be a binding contract with terms and properties that are strictly defined.
Note with options that when you purchase them you have a very clear right to do something but you are not obligated to do so. That means you can simply let the date go by and allow the option to expire – at which point that option becomes worthless. If this occurs, you’re out the money you used to buy the option.
Because options derive their value from an underlying asset, they are known as derivatives. In most cases, the underlying asset of options will be a stock or an index.
Options are broken down into two types – Call Options and Put Options. A call option gives the option owner the right to purchase assets at a locked price within a certain time window. When purchasing a call, the buyer is hoping the stock will increase substantially in value before the option expires.
A Put option gives the option owner the right to sell off an asset at a given price within a certain window of time. Buyers of puts often hope the price of the stock will drop off before the option to sell expires.
Advantages of Options Trading
1. Cost Efficiency
Options offer a great deal of leveraging power for investors. You can obtain an option position that will mimic a stock position almost identically but you can do so at a significant discount in many cases. A good example would be an investor looking to purchase 100 shares of a $60 stock. In this case they would need to pay out $6,000. If an investor were to purchase two $20 calls, with each of those contracts representing 50 shares, the total cost would be only $2000.00 (2 contracts x50 shares per contract x $20 market price). While that seems simple there is the requirement that the investor has to pick the right call in order to mimic the stock position. This strategy of stock replacement is one of the many advantages of purchasing options for investors.
2. Less Risk
Above we states that options were risky, but there is an advantage of less risk. It just depends on how you use the options. Options can be less risky for investors because they require less financial commitment than other equities. There is also some reduction in risk due to the fact that options are relatively impervious to the chaos that sometimes results from gap openings (the large break between prices on charting that occurs when the price of a stock makes a sharp move up or down with no trades between.)
3. Great Return Potential
Investors often trade options for their return potential. You don’t need a calculator to understand that if you spend less money and make nearly the same profit that you can wind up with a higher return at the end of the day.
This information is for educational purposes only and in no way guarantees your profitability by trading the equities mentioned. See Terms and Conditions.