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Understanding the Advantages and Disadvantages of Options for an Effective Option Trading Strategies
0 Comments | Posted by Jeff in Uncategorized
by: Daniel Webb
This article looks at the potential advantages and disadvantages of using options. Considering these are vital for investors and present an aspect to investors in inventing their option trading strategies.
What are the Advantages?
Options contracts provide a number of potential advantages to holders and writers:
Benefits for holders
Security
Call options give those investors wishing to protect their existing positions a way to ensure that their underlying assets (e.g. stock) can be sold at a certain price within a given time frame.
What’s more, put options potentially offer investors a way of considering at the same time as concurrently preventing their losses: in terms of say an option to purchase stock, the holder’s maximum potential loss would be the cost of the option (which would be realized in the case that he/she does not use the option); by contrast, were the investor to invest directly in the same stock, his/her probable loss would be the whole price of the stock (e.g. if the stock became of no value).
In addition, as options impose a fixed obligation on writers independent of market changes, it also create the potential for those correctly positioned to generate profits even when the market is falling.
o Leverage
Furthermore, as holders of put options, investors can potentially get “more bang for their bucks” (i.e. higher returns on their investments (ROI)) by managing further equity with their funds than would be the case if they were to acquire the important essential assets outright.
Advantages for writers
Options also offer some potential advantages to writers. For instance, in a “covered call” (i.e. where the option writer is the owner of the property that is the subject of the option), the options premium with regards to that property can stand for an added source of income for the writer (without the writer having to dispose of that property) if the option expires before being executed
General advantages
Also, the present market bid all investors, whether they hope to be holders or writers, with a broad collection of option contract models of varying complexity.
What are the Disadvantages?
There are several potential disadvantages which investors should bear in mind while designing their option trading strategies.
For instance, unused options are of no value once they have expired. Hence, if it has not been exercised prior to its expiration date, the holder will have effectively wasted the premium.
Furthermore, as noted above, options can be extremely complex and can require a good deal of market observation in order to be used effectively.
Tips for new investors
Novice investors thinking of becoming holders should first consider their own risk profiles: they should decide whether they wish to use options to leverage their existing capital, or to protect them against unwanted near-term market fluctuations (as above).
Investors must also consider brokerage fees when taking into account the cost of options contracts. Indeed, the cost may be higher on a percentage basis than the cost of trading in the underlying stock.
In addition there are a lot of approaches accessible to investors, some are more risky than others. The novice investor would be best off avoiding the high risk end of the spectrum (e.g. becoming a writer on an uncovered call, i.e. where the writer grants an option over property that he or she does not possess – there is no hypothetical boundary on the losses that the writer may get under such an arrangement).
All investors should understand the potential for options contracts to generate losses (e.g. where the amount of the premium cancels out the income based on the possession or disposal of the underlying asset.
Lastly, it may be more advisable for beginners seeking to make money trading stock options to initially only enter into options contracts as holders, rather than writers (owing to the greater potential risks facing writers).
The information presented in this article is by no means complete. Naturally, there are a lot more aspects one should think about in putting together effective option trading strategies prior to pitching into this potentially profitable venture and definitely, one would be sensible to completely comprehend the consequence beforehand.
Visit my blog on more information about how you can make money trading options and grab some free ebooks and e-courses along the way: http://www.savvyfinancialtraders.com
