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Options Trading - Advantages and Disadvantages
What is Options Trading?
An option is simply granting 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 purchase that underlying Dow future at a specific price,
known as the "strike price," at a future point in time, known as
the "expiration date." When an investor buys a put, they are
essentially selling the market; a call essentially buys the
market. Likewise, selling a put essentially buys the market;
selling a call essentially sells the market.
In order to receive the opportunity to buy an option on this
future, investors pay a "premium." If the market does not reach
the strike price of the option, then that option will expire
worthless on the expiration date. If the market does reach the
strike price of the option on the expiration date, then 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."
Leverage. An investor can gain leverage in a stock without
committing to a trade.
Limited Risk. Risk is limited to the option premium (except
when writing options for a security that is not already
owned).
Hedging. Options allow investors to protect their positions
against price fluctuations when it is not desirable to alter the
underlying positon.
Disadvantages of Options Trading
Costs. The costs of trading options (including both
commissions and the bid/ask spread) is significantly higher on a
percentage basis than trading the underlying stock, and these
costs can drastically eat into any profits.
Liquidity. With the vast array of different strike prices
available, some will suffer from very low liquidity making
trading difficult.
Complexity. Options are very complex and require a great deal
of observation and maintenance.
Time decay. The time-sensitive nature of options leads to the
result that most options expire worthless. This only applies to
those traders that purchase options - those selling collect the
premium but with:
Unlimited Risk. Some option positions, such as writing
uncovered options, are accompanied by unlimited risk.
Overall Options present a good opportunity to formulate plans
which can take advantage of volatility in underlying markets as
well as price direction. However for most traders the
disadvantages are significant and online futures trading is
usually a better option.
Tim Wreford runs Online Futures
Trading, a website that provides information and resources
for traders. Tim also provides a free
day trading system, the results of which are updated daily on
the site.
 MORE RESOURCES updated Fri. March / 05 / 2021
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"Is it important to be creative in your trading?" I'm not
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I received an email this week with a question (below) which
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A broker is any person or firm that charges a fee in
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