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I need to be clear about this one. Options CAN be an incredibly useful investment tool but they are NOT for every investor. Due to their leverage and maturities they have inherent risks that NOT all investors should expose themselves to. Please consult an advisor before considering options as part of your portfolio.
Question: What would you do if you thought the markets were going up? Going down? Or staying the same? Answer: Well, if you were me, you could consider using options in either of the above scenarios and still be in a position to make money.
Below I have identified 7 reasons to use options and how they could benefit your portfolio:
1) Options offer the potential for huge returns. Options use leverage. One options contract is the equivalent of 100 shares in the underlying security therefore, each move in the underlying security translates to a greater move in the price of the option. This means you as the investor have the opportunity for potentially greater returns but be careful, it also means there are greater risks.
2) Options can be profitable even when stocks are not going up or down (i.e. ‘stuck in a range’). Stocks require movement either up or down to make money while options can be profitable when stocks are in a holding pattern or going nowhere in terms of price. This is because all options contracts have an expiration date and once the option has expired, the investor can initiate a new contract with new terms. This can be done month in and month out, which brings me to reason #3 – Income.
3) Options can be used as a source of income. Because options have an expiration date, they can be used to generate an income stream by simply repeating the same options strategy over multiple expiration dates (i.e. monthly, quarterly, or any time the market allows) after each option expires.
4) Options can be used as insurance. If your goal is to hold a particular stock or group of stocks over an extended period of time but are concerned about significant price fluctuations, you can purchase an option to offset or protect against any potential losses due to a drop in price. This ‘insurance’ comes at minimal cost, which is essentially the premium that you pay.
5) Options are a good way to add value to existing positions. In addition to #4 above, if you plan to hold a stock or group of stocks for an extended period of time, writing options could be an excellent way to add value to your investment without selling the stock. In this particular options strategy, you would be able to add profit to the final sale of the stock. If you do not end up selling the stock then I’m sure you would be happy with the income/gain generated in the meantime.
6) Options are affordable. Due to the fact that options are leveraged, they can be a great way to invest in stocks without having to fork over a lot of cash to pay for the trade and if the trade goes against you, your downside risk would be limited to the premium paid.
7) Options offer flexibility. We all know that stocks can only be purchased at the current market price but options can be bought or sold at a variety of different strike prices and expiration dates. This unique set of circumstances offers the investor a huge a number of different strategies with a wide variety of outcomes. This could prove to be invaluable as it specifically addresses the investor’s objective.
In summary, I am certain that the use of options could benefit most portfolios depending on objectives and risk profile, however, I would suggest that you speak with your investment advisor to determine suitability and review which strategies might work best.
The information contained in this article is for information purposes only, and represent the views of the author. It is not intended as specific investment or financial advice, or a recommendation or solicitation to buy or sell any security. Any investments or strategies listed in this article may not be suitable for all investors. Past performance is not indicative of future performance, and as with any investment, prices may fluctuate. It is recommended that advice is sought from a qualified investment professional prior to implementing any financial plan. LOM has made every effort to ensure that the contents herein have been compiled from sources believed reliable, however LOM does not warrant the accuracy, adequacy, timeliness, or completeness of this information expressly disclaims liability for errors or omissions in this information.
