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When I decided to start investing in the stock market, I began doing some research and quickly became overwhelmed with all of the information. Instead of finding answers to my questions, I started asking more questions.
I fell deeper and deeper into the wealth of information at my fingertips that can be found online.
What can be especially confusing to many people is options and why exactly you would trade them rather than normal stocks.
You might choose to trade options rather than stocks because options require far less of a financial commitment to get the same possible returns. Also, options allow an investor’s involvement while limiting the potential losses at the same time and allow you the chance to profit from any movement of the underlying asset.
I took the research I did online along with my personal knowledge and put this article together for you. That way, you have everything at your fingertips.
Hopefully by the time you read this article (or other articles on the site) you will better understand options and trading them.
To see the most popular books about trading options just click here.
Why Trade Options Instead of Stocks?
One of the big questions I found myself wanting an answer to was, “Why should I trade options instead of stocks?” It seems that there are a few reasons for this that can make choosing options over stocks attractive to a potential investor.
Options can be less risky than stocks because they require less initial financial investment. Options also let an investor become involved in the market while limiting potential losses, and offer the potential to profit whether the stock’s value rises or falls since you can buy puts or calls.
When looking to make money in trading stocks, the ways to do that is relatively straightforward. With options, there are quite a few different, complex strategies available that can be utilized by investors that make options a flexible and diverse way to become involved in the market.
Another reason I found options to be more attractive than trading stocks is that as a buyer or seller of options, I have the potential to profit from any movement of the asset. I won’t only benefit if an asset increases in value, as one does when trading stocks.
Trading Options Involves Less Risk
If the right strategies for a given situation are used when investors trade options, there can be a profitable risk to reward ratio. You also have the ability to choose how much you are willing to risk when trading options.
When trading stocks, it is a much more straightforward process. So while options require more research initially, the different types of available contracts that an investor can choose from allow them the flexibility to take less risk because they need less of a financial commitment.
Call options, for example, essentially will enable an investor to control the same amount of stock while involving much less of a financial commitment. Often 5-10% of the amount needed to buy a stock is used to buy an option.
Potential Gains From Any Movement of the Asset
Because of the various strategies and contracts available when trading options, an investor can earn gains whether the market is moving up or down.
With stocks, an investor needs to be bullish all the time, which generally means that an investor wishes and believes that an asset will increase in price.
Options allow an investor to pick strategies where they may realize gains, depending on their chosen options, whether the asset is increasing or decreasing in value.
Trading Options Is Complex, Diverse, And Flexible
When trading stocks in the market, things are relatively straightforward. An investor makes money when the stock they have purchased increases in value as the market moves in an upward direction.
With options, there are a variety of different strategies an investor must learn about before they make a decision as to what to do.
Because of the complexity and variation in strategies with options trading, it can be a rewarding experience to learn and make smart investment decisions.
An investor does not simply need to think about what asset believes will grow in value; there are many different types of movement involved with lots of different strategies making options a flexible and exciting choice.
Options Give the Investor Leverage
When it comes to investing, leverage is a powerful thing. When trading stocks, you are buying a specific amount of an asset. It is a straightforward process.
With options, an investor is able to turn a relatively small amount of money into significant profits. What this means is that they allow an investor to multiply the power their initial capital has.
This is because, generally, the cost of options contracts is much lower than the price of the stock purchased outright.
Let’s imagine you have $500 to invest, and you want to invest in Company A. You want to invest in Company A because you believe Company A’s stock is going to increase in value.
If Company A stock were trading at $10 per share, you would be able to purchase 50 shares. If the stock rises in value to $25 as you hope it does, you could sell your shares for a $750 profit ($15 a share times 50 shares).
Let us now assume you decide to invest in call options instead, which are just one of the many strategies you could choose from.
The call options contracts are selling for $1 with a strike price (the price at which a contract is bought or sold) of $10.
If the contract size is 100, you could buy five contracts at $100 each, which means you essentially have control over 500 shares in Company A instead of the 50 shares you would control when buying stocks.
If the price of Company A stock goes up to $25 a share, you will make $7,500 ($15 a share times 500 shares) when selling your options.
So with the exact same amount of money you could make 10x more profit when using options over regular stock shares.
However if the stock price stays stagnant until expiration then you will lose your original $500 investment in the call options. Whereas with the stock you would not lose anything with a stock price that stays stagnant.
I believe that I still have a whole lot more to learn, but I’m willing to put in the work. The thought of getting involved in trading is an exciting one to me but something I know many people have been hesitant to try because of the risk involved.
While I do think I will do a bit of trading in the stock market. At the same time, I research more about options strategies, the prospect of understanding more about them is enticing.
Although they can be risky and losing money is a real possibility, if you pick a good strategy and stay with it you can certainly profit from options.