Stocks are arguably one of the most popular financial instruments among investors, partly due to their money-making potential, partly due to the relative simplicity of buying or trading stocks.
However, seasoned traders also take advantage of other opportunities, which are definitely more complex to understand but in return, provide plenty of benefits that stocks can’t offer. Options trading is one of them as it comes with an array of pros really worth consideration. Here is what you should know about trading options and how it will benefit you.
What Is Options Trading?
Let’s start with the definition of an option. An option is a contract that gives the buyer (or seller) the right – without any obligations – to buy (or sell) an underlying asset at a predetermined price on or prior to a certain date. The process of buying an option that lets investors buy or sell shares later is called a “call option” or a “put option” respectively. Options are traded on the stock market.
While options trading delivers a plethora of ways to make money, everyone who is plotting to give it a shot has to understand that it’s a pretty complicated concept, which requires certain knowledge. That’s why it is essential to familiarize yourself with the basics of options trading and have a clear vision of what’s it all about.
Even though options trading is similar to stock trading (in both cases traders make a profit through buying stocks/options and later selling them at a higher price), the difference between the two is that options trading is far more diverse as options come in a variety of types and options contracts can be based on a broad range of underlying securities.
Benefit #1: Flexibility
In contrast to the majority of passive investment variants (and even some active ones), options trading offers great flexibility both in terms of the available ways to make money and viable strategies. First of all, you can buy or sell options based on an extensive range of underlying assets. Secondly, you can speculate not only on stocks but also on the price movement of foreign currencies, indices, and commodities.
Options trading lets you a host of opportunities to keep track of the market conditions and how they affect the price of an option. By comparing weekly and monthly options, you can figure out the best way to trade for you. Weekly options expire each Friday and represent a cheap way for the retail trader to get into a trade. However, monthly options have their own virtues, giving you time not to rush to conclusions and to make the right decision.
Benefit #2: Risk vs. Reward Ratio
While every type of investment carries a certain risk, the risk versus reward ratio is something that can tell you whether the whole story is worth a shot. Whatever the subject, the rule of thumb is that the higher the potential return, the greater the level of risk involved. On the bright side, a trader is the one to determine the level of risk he or she is willing to take and act accordingly. Considering a wide spectrum of options contracts available for trade and the various orders available for placement, options trading provides for numerous opportunities to limit the potential risk. By the way, the more you learn about this type of trading, the better you realize its unique abilities to manage risks.
Benefit #3: Cost Efficiency
It’s no secret that the main (and only) reason why people get involved in trading is the profits this activity delivers. Well, options trading makes it possible to get impressive profits without a huge initial capital. This is not to say that it’s a great solution only for investors who operate with a modest starting capital – big players are welcome too. The use of leverage is the main key to the striking potential for generating sizable profits, which, in its turn, is an obvious advantage that other financial instruments simply do not offer.
To achieve the cost-efficiency of your investments and trades, you just need to take a particular position on the relevant underlying security. The latter is done with the help of numerous strategies created to decrease the cost of taking certain positions.
Options trading brings high rewards but only to those investors who have a deep understanding of this concept, as well as clear strategies for reaching their financial goals. Successful traders swear that investing with options is all about customization, hence think of a strategy able to cater directly to your needs and current position in the market.