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 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.

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 controlling more equity with their money than would be the case if they were to purchase the relevant underlying assets outright.

Benefits for writers

Options also present a number of probable pros to writers. For example, 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 example, unused options are worthless once they have expired. Therefore, if it has not been implemented before its expiration date, the holder will have efficiently 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. 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 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 amount of the premium cancels out the income based on the possession 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