Benefits & Risks of Options Trading
You may be wondering - why would an investor want to get involved with complicated options, when they could just go out and buy or sell the underlying equity? There are a number of reasons such as:
- An investor can profit on changes in an equity’s market price without ever having to actually put up the money to buy the equity. The premium to buy an option is a fraction of the cost of buying the equity outright.
- When an investor buys options instead of an equity, the investor stands to earn more per dollar invested - options have "leverage."
- Except in the case of selling uncovered calls or puts, risk is limited. In buying options, risk is limited to the premium paid for the option - no matter how much the actual stock price moves adversely in relation to the strike price.
Given these benefits, why wouldn’t everyone just want to invest with options? Options have characteristics that may make them less attractive for certain investors.
- Options are very time sensitive investments. An options contract is for a short period - generally a few months. The buyer of an option could lose his or her entire investment even with a correct prediction about the direction and magnitude of a particular price change if the price change does not occur in the relevant time period (i.e., before the option expires).
- Some investors are more comfortable with a longer term investment generating ongoing income - a "buy and hold" investment strategy.
- Options are less tangible than some other investments. Stocks offer certificates, as do bank Certificates of Deposit, but an option is a "book-entry" only investment without a paper certificate of ownership.
Options aren’t right for every investor and are just right for others. Options can be risky but can also provide substantial opportunities to profit for those who properly use this very flexible and powerful financial instrument.
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