Options trading: Conventional wisdom tells us to place our money on an investment vehicle we are most familiar with and on investment vehicle we can benefit most. Since understanding the rise and fall of stocks is much easier than knowing the basics of options trading, it is a more popular choice for the many. But the fact is options trading provide several advantages than any other investment vehicles, including the stock market or even the Forex.
Let us look at some:
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 stocks selling at $50 per share, he would have to pay $15,000. But if he would choose to purchase three $20 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 would then have an extra $9,000 to spend or invest on his or her discretion. The process is obviously not as simple as that. The investor would have to know which call to buy to have a good option position, similar to stock position. However, if you are looking for a good investment without risking large sum of money at once, option trading is the better choice.
Limited Risk Investment is said to be for the risk takers. This is good if your risk automatically yields to profit. But that is not always the case. In options trading, however, you can have unlimited profit potential and at the same time have limited risk. This is because options trading only give you the right to buy or sell underlying asset, and not the obligation. Meaning, if the price is not right at the end of the contract, you can just ignore and let the contract expire. If, however, you can profit for the change in shares prices, you can assert your right and pursue the contract. For example, you buy a certain call option for $20 (strike price) that will end on the third Friday of March.
On the expiry date, shares you bought are trading at $25. Definitely, you can instantly earn $5 per share and would have to pursue with the contract. What if the at the expiry date is lower than the strike price? Let us imagine that the shares you have bought went down to $15 or even $5 at the end of the contract, do you have to pursue the contract? No! You just have to let the contract expire. What have you lost then? The option premium you paid the seller. Nothing more.
Unlimited Profit Potential Say a certain call option you have bought is now trading at $38 per share. You can exercise your right to buy it for the strike price of $20 and earn $18 minus the Option Premium you have paid. This is just an example. The price of shares can go higher than that. And if you have carefully chosen your call, you can get the best profit without breaking your bank.
Note: if you are planning to pursue the contract and buy the shares, remember that you have to pay the full amount. So at the expiry date, make sure that you have the cash.