Options can add a lot more possibilities to your investing. It can initially be confusing trying to figure out how to trade options with all the option strategies and understanding how options move relative to stocks.
Here are the popular reasons why investors look at trading options :
Options for leverage
Leverage is usually the most common reason why people invest in options. You can control 100 shares of a stock with just 1 options contract with less capital. Options allow you to generate a significant return on capital vs. other instruments.
Futures which also offer significant leverage are marked to market every day so they risk the possibility of the position being closed out on you each day automatically. Also futures usually require larger initial investments than options.
Options offer Flexibility
Options offer a lot of flexibility with various strategies and investment goals. There are hundreds of options strategies that allow an investor to profit in up, down, and sideways markets.
You can use options to control risk, create income on existing positions, make leveraged bets, invest with limited capital vs. stocks, ecetera.
- You are already fully invested and want to protect your gains, you could buy puts.
- You have a retirement account and you want to generate more income, so you sell call options each month(or week) against your long stocks.
- You like a stock but don’t want to buy it until it gets to a certain level. You could sell put options every week or month at that price level to generate income until the stock gets to that price. If the price gets to your put strike price then you would own the stock and have lowered you cost basis from the sold premiums.
Options require Lower Capital
Options provide an investor with many ways to trade or invest with a stock without the same capital requirements of owning a stock. One option contract for a stock controls 100 shares, so rather than buying 100 shares of AAPL at $510 for $51,000 you could buy a call option for less than a couple thousand dollars.
You can also use certain option strategies that lower the capital requirements even more than with stocks with limited risk vs. stocks.
Also you can implement certain mult-leg options strategies to lower you capital requirements even more.
Options to Manage Risk
Options offer the ability to control risk and with the use of certain options strategies you can control how much you want to risk.
Some examples of using options to manage risk:
- You can use put options to protect downside on stocks you own.
- You could sell call options on your stocks to generate income and lower your cost basis.
- You can sell controlled risk credit spreads to generate a specific risk/reward on a small amount of capital.
- You can use specific expiration periods on options to manage your risk during earnings seasons.
Why Trade Options Summary
Those are the most common reasons why investors invest in options. Yes, options involve risk but with the proper knowledge of options and strategies you can invest profitably in any type of market with controlled risk.
There are so many possibilities with options, so let get into the next options lesson:
Next Options Trading Lesson : Understanding Options
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