Conventional wisdom tells us to invest our hard earned money in traditional vehicles we are most familiar with such as stocks, mutual funds, and bonds. Since understanding the up and down nature of the stock market, its generally more comfortable for many casual investors. The fact is, options trading provides several advantages that many regular investors are unaware of. Let's explore a few:
Leverage
Buying a call option gives the investor a good option position that is similar to stock position. For example, if an investor would by 300 shares of a given stock selling at $50 per share, they would have to put up $15,000. But if they would purchased three $20 in-the-money calls (each contract representing 100 lots or shares), he will only have to pay $6,000 (3 contracts X 100 shares/contract X $20 market price). The investor could then invest the $9,000 difference at his or her discretion. Buying deep in-the-money calls to simulate long stock, as an example, is a strategy that can not only reduce your capital outlay, it can provide an investor with enhanced returns (should the stock move in the intended direction of course!)
Limited Risk
Options are typically thought of as high-risk investments. While some strategies certainly have more risk than others, there are several ways and strategies to keep your risk limited.
For example, you buy a certain call option for $20 (strike price) that will expire on the third Friday of March. On the expiry date, shares you bought are trading at $25. Your $20 call has anintrinsic(or in-the-money) value of $5. Let's take the same example and imagine that on options expiry that the underlying is trading at $15. Assuming you purchased the $20 call for approximately $20, your loss would be approximately $5.
While there are many other factors that come into play like time left until expiration, implied volatility, and others, an investors downside is only limited to what he or she paid for the option (assuming it was a debit transaction). Option spread trades (both debit spreads and credit spreads), which are beyond the scope of this article, also provide limited riskopportunitiesfor traders that wish to know the maximum amount they can profit, and the maximum amount they can lose.
Profiting From Unpredictable Markets
When a typical investor makes a trade, he or she usually enters a long stock position. Some, though very few, engage in short selling. When the market experiences a decline, many long investors naturally see the value of thepositionsdecline. In addition, investors with long stock positions don't necessary benefit when theirchoseninvestment remains range, or channel bound. After all, if price doesn't appreciate, they aren't realizing any profit.
Options can provide profitableopportunitiesthat can be implemented in rising, decling, and even sideways markets.Specificstrategies can be implemented like long puts to take advantage of stocks in decline, without being short the stock. Iron condors can be initiated to profit from stocks that experience prolonged sideways movement. A long straddle can beinitiatedto take advantage of sharp price movements. It's possible to profit from the move, no matter which direction the move occurs.
Visit OptionsTeacher.com to learn more about sucessful options trading today.
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