Advantages Of Options
Blog 5: Advantages Of Options
Sam Hooker
Now that you have a better understanding of the basics of options, some of the advantages have become apparent. I briefly discussed the advantage of higher ROI in the “Calls and Puts” blog post, but other advantages include risk management, time, speculation, leverage, diversification, and income generation.
Risk Management
The widespread availability for investors to purchase a put means that they have the option to hedge against any loss to the underlying stock. This means that if I own a stock that has increased 25% this year and I am worried it is going to fall, but I do not want to sell it, then I can purchase a put. By purchasing a put while already owning the underlying stock is a risk management strategy.
Time
If an investor is attracted to a certain equity in the long run, but is unsure if the stock is going to generate returns in the short run than they can purchase a call. That way if the stock price falls the investor’s losses are protected, but if the price goes up then the investor can still purchase the equity for the same price.
Speculation
The ease and widespread availability of options makes it easy for investors who want to place bets on the market, but want to limit their loss. Investors can easily purchase and write options that they are able to either exercise for a gain or sell at any time for a limited loss.
Leverage
This section refers to the higher ROI associated with options previously discussed. Higher leverage in the market generally requires more risk, but the basics of options mean that risk is limited. If an investor is able to trade a $50 option for a $300 stock instead of spending $300, than the returns are going to be much greater.
Diversification
Options, similar to any other investment vehicle, provide diversification away from typical US Large cap equities or 10 Year Treasury-notes. Financial advisors today are criticized for diversifying by using the same instruments as every other financial advisor, not actually differentiating. Generally, these portfolios are made up of international stocks, emerging markets, environmentally friendly companies, and some maybe some health care. By adding options into your portfolio, investors can diversify away from typical “diverse” portfolios and can create something that is more powerful than just stocks and bonds.
Income Generation
By writing options, investors can collect the option premium each month paid by investors who cannot excursive them. By doing this investors risk having to trade in their shares if the stock goes above the strike price, but savvy investors who succeed at this will generate extra income.
In summary, options are a complex investment vehicle utilized by savvy investors who are looking to add one of the many advantages options come with to their portfolio. Although this blog post discusses the basics, investors should do more research on their own or speak to their financial advisor before making investments into these vehicles. As the economy becomes more volatile, interest rates are increasing, and uncertainty remains with the trade dispute between the US and China, investors are looking at niche areas of the market to create value, and options may be the answer.
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