Options investment strategy overview
Investing in stock options can be a useful tool in your investment toolbox if used correctly. A stock option gives you the right, but not the obligation, to buy or a stock, index or other types of funds at a specific price and on or before a specific date.
There are two different type of options that you can purchase:
Calls - A call option gives you the
right to buy a stock at a predetermined price at or before a predetermined period of time. Call options are like having a long position on a stock. Buyers of call options are hoping that the stock that the option is derived from will end up higher before the option expires at the predetermined period of time.
Puts - A put option gives you the
right to sell a stock at a predetermined price at or before a predetermined period of time. Put options are like having a short position on a stock. Buyers of put options are hoping that the stock that the option is derived from will end up lower before the option expires at the predetermined period of time.
Investors who buy the option are called holders and investors who sell these option are called option writers. Option writers are required to buy or sell the option they wrote if the holder wants to exercise his option right.
Investors can use options in two unique ways.
1) Hedging or protecting their positions - If they aren't quite sure if the market is going to continue in the direction they want and want to protect your profits they could purchase options that can protect against a change in the stock price. It's like an insurance policy you can buy in case the bottom of the market falls out.
2) Market speculation - Think of speculation as betting on what will happen to a stock in the future. Options give you the flexibilty to make money in bull, bear or flat markets.
Options investment strategy risk vs reward
Investing in stock options, especially market speculation, can be risky if you don't understand the time decay aspect and how options are valued. Options have a time premium included along with any value that is included. This time premium decays or decreases as time goes by. The last 90 days (and especially the last 30 days) the option time premium rapidly decays into zero at expiration.
On the other hand, investing in stock options can also be very rewarding especially in strong bull markets like the dot com bubble. Option values were skyrocketing everyday. Option trading can be profitable if used correctly and in the right markets.
Options investment strategy time to manage
Investing in stock options is a little more time consuming than investing in the stock itself. The movement on options are more dramatic in both up and down markets thus taking more time to follow.
Options investment strategy advantages
Investing in stock options uses one of the the highest uses of leverage in the stock market, which can lead to huge gains if successful. Options investment strategy disadvantages
Investing in stock options does have some disadvantages. The option spreads on a percentage basis will eat up a hefty chunk of your profit along with market anticipation. If the market is going up the call options seem to be priced higher. The problem is when do you sell. You're almost forced to consistently anticipate a tops and bottoms in stocks. This will usually lead to gains quickly disappearing when a stock turns the other direction. The high leverage used in option trading will also lead to huge losses when you are not successful in predicting a stock direction and timeframe.
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