Why Trade Options?
An intelligent investor can use
options to make a profit in any type of market, whether prices are rising, falling or flat. There are many ways of
profiting from options trading, we will outline a few of them here.
Options can be used to speculate on movement in the price of the underlying asset of the option. Depending on
the chosen strategy, trading options in either calls or puts (an explanation of calls and puts is outside the scope
of this article) can offer unlimited potential gains with a fixed potential loss, a long position, or potentially
unlimited risk and only limited potential profit, a short position. Speculating using options gives access to a
market at only a fraction of the potential market output - the options premium.
If you are working in a global market you should be aware that there are two basic types of options with one
very important difference in the way they are exercised. American options can be exercised at any time between the
purchase date and the expiration date while European options on the other hand are exercised only on the expiration
One of the main advantages in trading options is often considered to be in risk-sharing, usually implemented
through hedging, so-called because you are putting up a 'hedge' to protect yourself. If used correctly, options can
actually reduce overall risk by protecting your investments from price fluctuations. This is like insurance against
the fall in price of some asset that you want to keep. Let's say you own some gold, and you're worried that the
price of gold is about to drop severely, but you don't want to actually liquidate your gold assets. You could just
buy a put option (recall a put option is the option to sell) for the underlying gold assets allowing you to sell at
the current price in case the price of gold drops too low. Of course, if the price of gold remains stable or
actually strengthens, you can always choose not to exercise the option, but of course you've already paid for the
Options trading can also provide a convenient alternative to difficult or time-consuming transactions when
making short-term adjustments to your portfolio. Options can be used to quickly adjust market exposure without
changing your physical holdings or liquidating assets needlessly.
A Note About Company Stock Options
There is often confusion among non-investors about stock options because they are so often referred to as part
of employee benefit programs. There is really nothing to be confused about, employee stock options are simply a
specific type of options contract between the employer and the employee giving the employee the right but not the
obligation to buy company stock at some price. Employee stock options can often be highly lucrative, but
unfortunately they are typically only available to company employees.
Finally, options can be used to supplement your overall returns by providing an alternative means of
manipulating your market position. Don't get me wrong, options aren't for everyone; don't start trading options
just to make yourself feel like a real investor. When you buy an option, make sure you have a specific plan or goal
in mind and give serious thought to whether the premium is worth the expected benefits.