Why Use Options?
In the previous chapter, we have mentioned that to trade options is a risky business. If you have studied the example in that chapter, you will discover that it is entirely possible to lose 100% of your investment on a single contract by letting it expire.
Now, you might ask, why let the contract expire then?
You see, the underlying asset which the contract is tied to changes in value overtime. What if it plummets in value and decreases by more than your cost of purchase of the contract? In such situations, it makes more sense NOT to exercise the option and just let it expire.
So why use options if they are so risky?
There are two significant benefits of using options.
1. Speculate the Market – The main concept taught by value investors is to “buy low, sell high” and you earn the profit. This is intuitive, but what if the market goes down and it is impossible to invest the traditional way? This is where options come in. With options, you are able to make money even if the asset value goes down or sideways. The freedom to make money under any kind of market conditions proves to be one of the key selling points of options trading.
2. To Hedge – Hedging is act of protect yourself from risk. Think of it as purchasing insurance. For example, if you believe that your car is going to decrease in value, you may purchase an options contract that allows you to sell the car to a buyer at a pre-determined price. If the car falls below that pre-determined price, you can exercise that option and you effectively hedged yourself from that price drop!
How To Trade Options
Calls and Puts
How Options Work
Types of Options Orders
Valuation of Options
Choosing The Best Options Broker
Leverage in Trading Options
Mistakes Options Traders Make