Why Trade Options?

Speculation

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 date.

Protection

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 option itself.

Short-Term Adjustments

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.

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