Why Options

Description: Options Trading, Trading Strategy, Investing, Strategy, Options Strategy, Trader

Speculation

Speculation is the main reason that many traders become involved in the options market. This is why options trading has become so popular. The great leverage offered in options trading attracts speculators who are willing to accept the risk of investing in a trade (where 100% of the investment could be lost) in exchange for an opportunity to obtain greater and quicker returns (where the profit is unlimited) than if the same funds were invested in stocks.

One option contact corresponds to 100 shares of the underlying stocks. A trader’s purchase of 10 option contracts is equivalent to investing in 1,000 shares of the underlying security. However, an option has an expiration date and a tendency to lose value over time. Therefore, an option buyer risks the loss of 100% of the premium that he paid for the option because, if the option expires, it will be worthless. At the same time, an option seller risks losing significantly more than the premium that he received when he sold the option.

Portfolio Protection

An investor may choose to use options to protect a portfolio. The options can be used to protect the stocks that he owns against a sudden downward price movement.

This trading strategy is considered to be very conservative and is used in buying puts as a hedge. Basically, a trader buys a right to sell stocks that he owns at a certain price (strike price) and, in the case of a sudden drop in the stock price, he has the right to exercise the put options and sell the owned shares at a strike price or sell the owned puts and pocket a profit that may help him to keep the shares during the downswing. In the case of a Bull market, this strategy limits the profit potential by the cost of the purchased puts.

As a rule, this strategy is used when an investor believes that there is a possibility of a Bear market in the short term, but is unwilling to sell the shares he owns.

Additional Income Generation

Options can be used to create additional income. This is a conservative strategy that is based on selling calls (writing covered calls) on the stock that he owns. In this case, a trader expects to receive additional profit in a flat or moderately low market when there is a strong possibility that the sold call options will expire and be worthless. Since the profit from the selling options is limited to the amount received as a premium for the options that he sells, a trader may still lose more on the owned stock in the case of a strong decline. By using this strategy, a trader who does not wish to sell stock during a Bear market, may generate some additional income.

In general, the "Portfolio Protection" and Additional Income Generation" options strategies are very similar. Both help the trader to keep his owned stock during a Bear market by generating additional income from selling calls or from the bought puts. Both of these options strategies are used when a trader expects a moderate downward correction within a major uptrend and is unwilling to sell his owned stocks. If a trader expects a strong Bear market, he is always better off by selling his owned shares, since the profit from the sold calls or bought puts may not always cover the losses on the stock portfolio.

 

Trading System - Signals - Options Tutorial - Index Trading - Technical Analysis - Glossary - ETFs - Quotes

Financial and Investments Directories: Banking - Brokerage Services - Currencies Trading - ETFs Trading - Mortgages and Loans - Futures Trading - Insurance - Mutual Funds - Options Trading - Stocks Trading