How options can benefit you
There are a number of reasons an investor/trader may get involved in options:
• Leverage
• Earning Extra Income
• Protecting the value of your shares
• Capitalizing on share price movements without having to purchase shares
• Time to decide what to do
• Index options let you trade all the stocks of an index
• Multiple strategies to limit risk
Leverage
First and foremost, a trader will choose to trade options over shares because of leverage.
In finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns.
Options generally cost a fraction of a share price, but increase (and decrease) and a higher percentage to the stock price movement. There are many other factors involved with leverage in options, which are explained throughout this document.
Earning Extra Income
Writing options against shares you already own or plan to purchase can be one of the simplest and most rewarding strategies.
• Writing options against shares you already own
• Writing options at the same time as buying shares
• Writing options to sell your shares above the current market price
Protecting the value of your shares
This strategy can be useful if you are a shareholder in a particular company and are concerned about a short-term fall in the value of the shares. Without using options you can either watch the value of your shares fall, or you could sell them. Using options could give you some protection from this decline.
Writing call options to give you downside protection
Take (purchase) put options
Capitalizing on share price movements without having to purchase shares
You can profit from a movement, either up or down, in the underlying shares without having to trade the underlying shares themselves.
Take (buy) calls when expecting the market to rise
Take (buy) puts when expecting the market to fall
Using options gives you time to decide
Taking a call option can give you time to decide if you want to buy the shares. You pay the premium, which is only a faction of the price of the underlying shares. The option then locks in a buying price for the shares if you decide to exercise. You then have until the Expiry Date of the option to decide if you want to buy the underlying shares.
Put options can work in a similar fashion. By taking a put option you can lock in a selling price for shares you already own and then wait until the Expiry Date to see if it is worthwhile exercising the option and selling your shares. Otherwise, you can let the option lapse and continue to hold your shares.
In both cases, the most you can lose is the premium you have paid to purchase the option in the first place.
Index options let you trade all the stocks in an index with just 1 trade
By using call and put options over an index, you can trade a view on the general direction of the market, or hedge a portfolio with just 1 trade. If you are bullish on the market but don’t know what stock to buy or which sector of the market will rise, you can buy a call option over the whole index. This means you don’t have to choose a particular stock to invest in, you can just take a view on the direction of the broad stockmarket. If the level of the index rises the value of the call options will rise, just as for call options over individual shares.
Other strategies
Options can allow you to construct strategies that allow you to take advantage of many market situations. These can be quite complex and involve varying levels of risk. What this allows the trader/investor to do is benefit from market conditions where there is a lack of direction, or when markets are falling.
To read the full article, you will need to go to: http://fmranalysts.blogspot.com/2006/10/articles.html
Source: http://www.ArticlePros.com/author.php?Matthew Brown
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