There is lots of material on investing and ways to make money in the market, whether it be stocks, commodities or currency. There are lots of systems which point to ability to get large profits. However, I find the most under-discussed financial trading instrument is options.
There are a couple of reasons I believe this to be true. First, most people don’t fully understand stock options. Many believe that stock options are items that corporate executives get as part of their compensation package. While that understanding is partially correct (i.e. corporate executives frequently get stock options as part of their compensation), the majority of stock options have nothing to do with corporate compensation. Stock options are bought and sold daily in the billions. You don’t need to be given them, you don’t need to be an executive, you don’t even need to be a broker. Any person can buy and sell options. In fact, many consider generating profit with options as the best vehicle for the average investor.
Second, conventional wisdom tells us to place our money on an investment vehicle we are most familiar with and on investment vehicle we can benefit most. Since understanding the rise and fall of stocks is much easier than understanding options trading, it is a more popular choice for many.
It is easy to dismiss the benefits of a trade if the most typical description attached to it is risk. But it should not be so. There are great benefits that may be taken from participating in options trading that most people overlook. One should take into account that all types of trades have inherent risks but they also offer advantages in return.
The fact is options trading provide several advantages over other investment vehicles, including the stock market or even the Forex market. Let us look at some:
Leverage
Since the trader bought the “option” and not the stock, he could profit with very little investment. By coughing up a small amount, the trader can control the full value of the stock because he holds a contract that performs in the same way the stock performs but for only a fraction of the stock price. This is probably the main reason why option trading is very appealing to traders with small funds.
Let’s use Apple as an example. Apple sells at around $350 dollars a share. If you wanted to own 100 shares it would cost you approximately $35,000. However, you could buy an option to buy 100 shares of Apple at $350 for around $9 a share or $900. That’s a big difference for the retail investor. If you had $35,000 that you wanted to invest in Apple, you could buy the hundred shares or you could buy options on 3800 shares of Apple stock at $350.
If we assume the price of Apple stock goes up $10 to $360 a share, then you have made $1000 if you bought 100 shares of the stock. You have also made $1000 on the option you bought for $900. And if you bought the options on 3800 shares, then you have made $38,000.
So clearly, buying the option has given you better leverage of your money. You made about 3% from the stock, but 110% from the option. That’s the power of leverage.
Limited Risk
This is my key reason for trading options. From above you can see the power of leverage, however, that leverage can also accelerate losses if you don’t manage your risk. Options provide many ways to limit your investment risk.
Investment is said to be for the risk takers. This is good if your risk automatically yields to profit. But that is not always the case. In options trading, however, you can have unlimited profit potential and at the same time have limited risk. This is because options trading only give you the right to buy or sell underlying asset, but not the obligation. Meaning, if the price is not right at the end of the contract, you can just ignore and let the contract expire. If, however, you can profit for the change in shares prices, you can assert your right and pursue the contract.
For example, you buy an Apple $350 call option that will end on the third Friday of March. If on the expiry date, shares you bought are trading at $360. Definitely, you can instantly earn $10 per share and would have to pursue with the contract.
What if the at the expiry date is lower than the strike price?
Let us imagine that the shares you have bought went down to $340 or even $300 at the end of the contract, do you have to pursue the contract? No! You just have to let the contract expire. What have you lost then? The option premium you paid the seller (that $900 for the cost of the option). Nothing more.
Another factor in limiting risk is in using the combinations of options. There are many techniques here which we will discuss later, but their low cost, high leverage makes them ideal for limiting your risk.
Flexibility
Although it is true that options trading may not fit everyone, it still does not change the fact that to those traders who have made this approach to trading work for them, that options offer great flexibility for both the option buyer and the seller. That’s correct. You, the average retail trader, can sell stock options and you don’t even have to own the stock. You in essence become the broker. Most people don’t realize that you can do this and it is an extremely powerful capability.
The other element of flexibility, is the “put” option. Most people understand and gravitate to the “call” option, our example to buy a March $350 call on Apple. The logic is like owning the stock and therefore most people use the call as an option example. The stock goes up and you profit. But if you believe Apple is going to go down in price you can buy a March $350 put on Apple. This gives you the right, but not obligation, to sell 100 shares of Apple at $350. If the price of the stock at expiration is $340, you have made your $1000 again. This time because the price went down not up.
Neither the put option nor the ability to sell the option are elements of investing available to you with stocks, mutual funds, CDs, etc. That is why for investor flexibility, options are an excellent vehicle. On a final note, by working within the principle of option trading, the trader has the liberty to buy or not to buy an option depending on the movement. That, in itself, is a great benefit since the trader is not obligated to pursue with the purchase of an asset even when he has already lost interest on it. Since options are traded, just like stocks, you can sell (or buy back if you originally sold) your options prior to expiration (unlike a CD which must be held to maturity). This flexibility can further limit your risk on trades.
There are many strategies and combinations available to the options investor, which make these three key attributes of options both unique and powerful for the retail investor.
ZA3HSJ59GZ6U
