![Advantages and disadvantages of options trading](https://epsilonoptions.com/wp-content/uploads/pros-and-cons-of-options-trading-1024x512.jpg)
What are options
An option is a contract that allows an investor to buy or sell a share at a specified price at any time before it expires.
Option contracts typically cover 100 shares of a company. So if you buy the right to buy his Apple stock at a certain price, you get 100 shares in that company.
Please note that these agreements are different from stock options that employees may receive from their respective employers.
call options
By purchasing a call option, you are purchasing the right to purchase at a specified price (strike price) by a preset expiration date, but you are under no obligation to do so.
When you sell a call option, you agree to sell your shares at that price if the buyer assigns (or subscribes to) the option.
put option
A put option is a type of financial instrument that gives the buyer the right, but not the obligation, to sell a stock at a specified price within a specified period of time.
Advantages of options trading
Options have the following advantages for traders:
Limited downside (for buyers)
Option buyers may only lose the value of the premium they purchased (unlike sellers – see below).
(However, unlike owning stocks where you rarely lose everything).
smaller commitment
Options allow you to profit from stock price fluctuations without having to buy the actual stock. As a result, your potential earnings can be much higher compared to what you put in in the first place. If things don’t go your way, you just lose the contract premium.
flexible strategy
You can implement more investment strategies with trading options than with stocks.
Depending on the type of option and whether you are a buyer or seller, options can be used to protect your existing investment, provide additional income from your existing stock, or achieve any other investment objective.
For example, if you are bullish about a stock, i.e. expect it to rise, long call again bull call spread to take advantage of rising stock prices.
Similarly, bears can trade long put again bare put spread.
You can use options even if you think the stock will not move much.Options trading strategies such as calendar spreads and spreads iron condor You can trade profitably.
Disadvantages of Options Trading
However, the option has some drawbacks
complicated:
You should understand the terminology and regulations associated with options.
Therefore, it is advisable to stay away from them until you have acquired sufficient expertise in the stock market and studied its operation.
The option seller’s risk is potentially unlimited
For example, the seller of a call option with a strike price of $200 is obliged to sell the stock at this price at any time during the life of the option.
However, the stock can rise to any price, forcing the trader to buy at this price and sell at $200. The potential loss is therefore (theoretically) infinite (although this can be mitigated with good risk management).
low liquidity
The low liquidity of some stock options can present significant challenges for traders looking to enter and exit the trading market.
Option margin requirements can increase trading costs
One of the biggest costs associated with options trading is margin requirements. This is the amount you must deposit with the brokerage firm to open an options position.
The amount of margin required depends on the type of option traded and the underlying security.
fee cost
Options trading is expensive compared to futures and stock trading, especially for full-service brokers.
You may be able to use discount brokers such as Robinhood to cut these costs and trade for lower commissions.
Conclusion
There are many factors to consider when analyzing the pros and cons of options trading.
A safety net that defines the downside allows you to speculate on short-term price movements while preserving all the upside. In addition, option purchases have positive skewness. Statistically speaking, this means that most of the time you will lose a small amount and you may make a large profit.
The trade-offs are very profitable as only a few trades can pay off for a profitable month or year.
About the Author: Chris Young has a degree in Mathematics and 18 years of experience in finance. Chris is from the UK, but he has worked in the US and most recently in Australia. His interest in options was first aroused by the “Trading Options” section of the Financial Times (London). Determined to bring this knowledge to more people, in 2012 he founded Epsilon Options.
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