Why Options Trading? (Part 1)

There are a few reasons why people use options:

1. Require less capital

Options trading generally require less capital than the corresponding stock trading, because option price is only a small fraction of the underlying stock price. When a trader is confident that a stock price will move in a particular direction significantly within a short term, he can invest in options rather than in the stock itself to take advantage of the expected movement because of the limited risk, high potential reward and smaller amount of capital required to control the same number of shares of stock.

2. Protection

For an investor who invests in stocks, put options can be used as a hedging tool to protect your stocks from a price drop. When the stock price drops, the put option will increase in value, hence offsetting the loss in the stock. When the stock rises, the put option would simply expire worthless when the expiration date comes and you will only lose the price you paid to purchase the put options. So, here as if you buy put options as an insurance policy to protect your stocks from a price fall.

For an option trader, when the stock does not move in the expected direction, you should lose much lesser than a stock trader (in terms of dollar). Because the maximum you can lose is limited to the amount you spent to buy the option (premium), which is only a small fraction of the underlying stock price.

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