Investors who trade options can benefit in several ways. If you’re interested in learning more about trading options, it’s important to know what these are. Here are the top 10 benefits of being an option trader.
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Huge potential profits
For most types of assets, there is a known price range in which the asset will fall within with a degree of accuracy. This range is known as volatility. Option traders look to take advantage of aspects that determine this volatility to predict whether the price will move above or below the expected range, and then buy or sell accordingly. By correctly predicting whether prices will rise or fall, option traders can make huge returns even when there is little movement in the market. With only 30% – 40% returns, for example, traders can make 5 – 7 times their initial investments.
Control over position size
When trading stocks, investors are limited to the number of shares they can buy. Stock options, however, allow traders to control how much of an asset they own by purchasing contracts that represent a certain number of shares. For example, if you wanted to profit from a potential rise in Apple’s stock price but didn’t have enough money to buy 100 shares directly, you could instead buy one contract which controls 100 share worth of stock. This not only allows option buyers to limit the amount they spend on each trade but also gives them more leverage because it reduces the risk involved with investing in any trade.
Unlike other financial transactions, profits made from option trading are often considered capital gains and taxed at a significantly lower rate than normal income. This is since options provide traders with leverage which enhances their ROI without having to place as much of their own money at risk.
As mentioned above, because option contracts control a certain number of shares, option investors can make more money even if prices don’t move as much as they’d hoped. But for this same reason, they also have less to lose in the case where their prediction was wrong. When trades are placed directly on stock itself, traders stand to lose 100% of their initial investments or more if there’s a significant price movement contrary to their expectations. When options are used however, this risk is greatly reduced because the trader has only lost the price of the option itself.
Investors who want to diversify their portfolios can do so more effectively by incorporating stocks with different characteristics. As a result, they capture profits generated from not only dividends but also capital gains and stock splits. Stocks that pay high dividends or exhibit significant growth potential are ideal for option trading because they provide traders with more opportunities to win on trades.
Ability to set stop losses
Option trading has been around for quite some time now. However, there is still an ongoing debate about the capability of stop losses and their effectiveness in option trading. Many traders question whether it’s possible to set a stop loss at all while holding an option, due to its dynamic nature. Some would even go as far as saying that options don’t have stop losses, or they can’t be set at all! Let’s clear things up on this front once and for all, shall we?
Just like any other type of assets such as equity shares, commodities etc., options also have their own sets of advantages and disadvantages. And just like any other financial instrument, having access to them doesn’t really mean that you’ll win every trade you enter – unless you were the one who created the option in the first place. You can lose trading options too, and this is where stop losses come in to help you limit your downside risk. Now, let’s talk about how they work.
Stop Losses for Options
Option trading entails purchasing an option at a certain price and having the right to sell it at a pre-determined price (strike price) within a given period (expiration). The trade-off here is that you only have the right but not the obligation to execute the transaction. This means that when you own an option, you sit on “one side” of a contract which requires two parties: buyer and seller. Because it doesn’t cost much to enter a trade in options, so you can place multiple trades simultaneously. But let’s talk about the risks involved when you hold one of these pieces of paper in your hand.
If the market moves against your position, and instead of going up it goes down – causing a loss for you – your option will lose its value over time. This is normal and expected, but what happens if the bad news keeps piling up? The time value which makes an “option” out of a mere piece of paper will start to dwindle away, resulting in a material loss. As a seller who’s obligated to sell at a pre-determined price (strike price), this puts you under severe pressure because there is nowhere else to go except executing the transaction.
Ability to speculate
Option trading is the act of taking a trade position based on anticipated movement in the price of an underlying stock whether under of overweight stocks.
There are certain advantages and disadvantages to speculating in options, but there are also distinct differences between buying options and selling them. By understanding this basic difference, it will help you become better at making option trades that meet your financial goals.
The first way you can speculate in options is by buying calls or buying puts. When you purchase an option, you’re anticipating that the value of the asset will move beyond the predetermined strike price before expiration (in other words you want to buy low and sell high). With this speculation strategy, you can make money whether the price of that asset goes up or down.
On the other hand, when you sell an option you are anticipating that the value of the underlying stock won’t go beyond the predetermined strike price before expiration (in this case you want to buy high and sell low). If your prediction is correct, you will earn a profit on your call or put sale regardless of how much the asset changes in relation to its initial price because options have no intrinsic value.
When buying calls there is unlimited risk because all funds are tied up until expiration. Selling puts also has unlimited risk. When selling a call there is limited risk since only $100 can be lost but it still holds unlimited profit potential.
Ability to invest without directly owning the asset
When trading in the stock market, it is easy to purchase shares of stocks because you are exchanging money for equity. The stockholder receives dividends, could exercise voting rights, and claims to residual value if the company is sold or liquidated.
However , when an investor wants to buy a call option on Microsoft (MSFT), he does not actually own any equity in MSFT; rather he has purchased the right to buy MSFT at a fixed price ($27.08) at some point in time (i.e., up until January 17 th , 2015). This then begs the question: how do you make money with options?
You could be thinking – hold on! I thought options were much more speculative than owning an equity share. Well, options do offer a greater degree of risk than your typical stock investment and the pay-out is usually lower as well. However, by owning an option, you possess unlimited profit opportunities on the upside (i.e., if MSFT goes up) but only limited loss potential on the downside (i.e., as long as MSFT stays above $27.08). Thus, like stocks where some people believe they can find mispriced assets that will revert to their intrinsic value over time; we might also be able to use options trading combined with other strategies in order to exploit pricing anomalies across the option spectrum.
Option trading can be a great way to achieve all sorts of goals, from earning consistent income to building long-term wealth. But that’s just the beginning; there are many other benefits of option trading. For example, traders have more control over their position size than they do when buying stocks. This gives traders the ability to manage their risk in a much more controlled manner. Additionally, because options expire, traders are not subject to taxes until they actually sell the option (assuming it has expired worthless). This can provide significant tax savings for those who trade options regularly. Finally, because options offer limited downside and unlimited upside potential, they can help create a diverse portfolio with less risk. Have you tried option trading yet?