The Versatile Option

Jul 2, 2010
The Versatile Option

Options have many uses and are versatile investment tools.

Some uses for options:

  • To buy stock at a lower price (below current market price)
  • To sell stock at a higher price (above current market price)
  • To bet on the size and direction of a change in the price of
  • One stock
  • One segment of the market
  • The entire market
  • To protect an investment against a large loss
  • To provide additional income, similar to receiving dividends
  • To lock in an investment profit

Options can be used conservatively, but sadly, too people believe options are only for speculators.  When using options for your investment club portfolio, you must decide if you are interested in taking a conservative approach (highly recommended) or being more aggressive(mush riskier).  In playing it relatively safely, or in taking a chance to earn additional money.  The measure of risk vs. reward is a constant concern for all traders.  I hope to convince you to use options in a conservative manner.  I believe the profit opportunities available from the conservative use of options are sufficient so that it's not necessary to add risk to your investments.

Options are not for everyone, and there is no guaranteed profit when using options.  Both options and stocks are investments with potential for reward, but losses can occur, no matter how conservative the strategy.  By being aware of the risks at all times, you make better trade decisions.  Profit potential is substantial when options are part of your portfolio.

Let’s review the most basic definitions:

  • Call option – a contract giving the owner the right to buy 100 shares of a specified stock (underlying) at a specified price (strike price) for a specified period of time (until expiration).

  • Put option – The same idea as a call, but the owner has the right is to sell the underlying stock.

The simplest strategy:  Buying call or put options

If you buy an option, you are betting the price of a specified stock changes in the predicted direction (for calls, the direction is up; for puts the direction is down).  The risk of an investment of this type is limited; the loss cannot exceed the cost of the call option.  However, that does not mean that it's a good strategy.

Mark D Wolfinger

Expiring Monthly: The Option Traders Journal