Option trading: advantages and disadvantages
What is options trading?
One option is simply to give someone the right to buy or sell something in the future. In the case of Dow index futures options, when someone buys a Dow call option, they are buying the right to buy that underlying Dow future at a specific price, known as the “strike price,” at a future time. , known as the “expiration date.” When an investor buys a put option, he is essentially selling the market; a call essentially buys the market. Likewise, selling a put option essentially buys the market; selling a call essentially sells the market.
To receive the opportunity to purchase an option in this future, investors pay a “premium.” If the market does not reach the option strike price, that option will expire worthless on the expiration date. If the market reaches the option strike price on the expiration date, the investor will be assigned the underlying future at that strike price.
Advantages of options trading
Flexibility. Options can be used in a wide variety of strategies, from conservative to high risk, and can be tailored to more expectations than simply “the stock will go up” or “the stock will go down.”
To take advantage of. An investor can get leverage on a stock without committing to a trade.
Limited risk. Risk is limited to the option premium (except when options are issued for a security not yet owned).
Coverage. Options allow investors to protect their positions against price fluctuations when it is not desirable to alter the underlying position.
Disadvantages of options trading
Costs The costs of trading options (including commissions and bid / ask spread) are significantly higher in percentage than trading the underlying shares, and these costs can dramatically reduce profits.
Liquidity. With the wide range of different strike prices available, some will suffer from very low liquidity which will make trading difficult.
Complexity. The options are very complex and require a lot of observation and maintenance.
Time in decline. The time-sensitive nature of options leads to the result that most options expire worthless. This only applies to those traders who buy options; those who sell charge the premium but with:
Unlimited risk. Some option positions, such as underwriting uncovered options, are accompanied by unlimited risk.
The general options present a good opportunity to formulate plans that can take advantage of the volatility in the underlying markets, as well as the direction of prices. However, for most traders, the downsides are significant and futures trading online is usually a better option.