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 present a lot of potential advantages to holders and writers:
Advantages 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 put up for sale at a definite price within a specified 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 worthless).
Additionally, as options entail a permanent responsibility on writers independent of market changes, it also form the probability for those properly positioned to produce earnings even when the market is declining.
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 offer some potential advantages 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
In addition, the current market offers all investors, whether they wish to be holders or writers, with a wide range of option contract models of varying complexity.
What are the Cons?
There are several potential disadvantages which investors should bear in mind while designing their option trading strategies.
For example, unused options are worthless once they have expired. Hence, if it has not been exercised prior to its expiration date, the holder will have effectively wasted the premium.
Also, as noted above, options can be very multifaceted and can entail a good deal of market observation in order to be used efficiently.
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 should also factor in brokerage fees when considering 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 neophyte investor would be best off staying away from 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 must know the likelihood for options contracts to produce losses (e.g. where the size of the premium negates the profits made from the acquisition 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 offered in this article is absolutely not 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.
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