Mar
Identifying the Pros and Cons of Options to Ensure an Effective Option Trading Strategies
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 provide those investors hoping to guard their current positions a means to guarantee that their underlying assets (e.g. stock) can be sold at a certain price within a given time frame.
Furthermore, put options potentially give investors a means of speculating whilst simultaneously limiting their losses: in terms of say an option to buy stock, the holder’s highest potential loss would be the price of the option (which would be realised in the case that he/she does not exercise the option); by contrast, were the investor to invest directly in the same stock, his/her potential loss would be the total value of the stock (e.g. if the stock became worthless).
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.
Power
Moreover, as put options holders, investors can most likely acquire “more bang for their money” (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 present a number of probable pros to writers. For instance, in a “covered call” (i.e. where the option writer owns the property that is the subject of the option), the options premium in respect of that property can represent an additional source of income for the writer (without the writer having to dispose of that property) if the option expires before being exercised
General Pros
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.
Advise for new investors
Neophyte investors considering of becoming holders should primarily think about their own risk profiles: they should make a decision whether they want to use options to influence their present capital, or to keep them from unwanted near-term market fluctuations (as above).
Investors must also consider brokerage fees when taking into account the cost of options contracts. Undeniably, the cost may be higher on a percentage basis than the cost of trading in the essential 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 own – there is no theoretical limit on the losses that the writer may incur under such an arrangement).
All investors should understand the potential for options contracts to generate losses (e.g. where the size of the premium negates the profits made from the acquisition or disposal of the underlying asset).
Finally, it is much sensible for newbies who are looking to make money through stock options trading to primarily go into options contracts as holders, rather than writers (due to the larger possible 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
