How To Use Options As A Strategic Investment
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Nowadays, people are exploring online trading as an additional source of income. After all, it’s one of the common ways to make money online and with the volatility of the current market, there are great financial opportunities to be had. But as everyone knows, trading stocks can be risky. But by using options, one can make money in the market while hedging their risk and really protect their investments. Let’s dive into Options trading…
What are Options and how can you use it as a strategic investment?
What are Options?
Options are financial products that serve as derivatives of underlying assets like stocks, bonds, ETFs, and even mutual funds. What does that mean? Essentially an option is the right to be a a stock, bond or other assets. It’s just a vehicle (or document) that says, I paid a certain amount of money to have the right to buy or sell that specific asset. It is often compared with futures, however, in options, you are not obligated to buy or sell the asset.
There are two main components of Options trading —calls and puts. Essentially, a call option allows you to buy an asset while a put option allows you to sell one. These two sections depend on the type of assets you handle. No matter what type of asset, each contract is bound to a specific time frame where you can exercise your buying or selling option. What does that mean? Well when you own an option you have a certain period of time before that option expires. You can let it expire (and therefore you’ve lost the money you purchased the option for) or you can exercise that option (the call or put) before the deadline.
Generally, options are used for additional income and to evaluate and hedge risks.
Why is it a Good Investment?
Options are versatile financial instruments that help traders assess their investments better. Aside from the additional income it generates, Options can also be used as protection and leverage to attain investors’ goals.
Normally, people use options as an effective hedge against a declining stock market to limit downside losses. Others also use it for speculative purposes such as wagering on the direction of a stock. These activities can be done because Options hold valuable information about the market of its underlying asset. This can be found in an Options chain.
One of the key aspects of an option is that you get to control the underlying asset (stock, bond, mutual fund, etc) with a minimal amount of money. So you know upfront that the most you can lose is the value of the option (which is typically just a fraction of the price of the asset itself). The options can be
What is an Options Chain?
An Option chain provides an overview of relevant information about Options trading. Although not all public stocks have options, those that do present helpful information that can get you ahead in your investments. Understanding options charts can give you insights on the security today and its direction in the future.
You can find real-time option chains on most financial websites that feature stock prices. These include The Wall Street Journal Online, Yahoo Finance, and online trading sites, such as Charles Schwab and TD Ameritrade.
Usually, once you find the chart of the underlying stock, you can also see a link to the related options chains. Option chains summarize all calls and put sections of an underlying asset and its respective price within a given timeframe.
Other information you should take note in option chains includes premium, fluctuation, and the open interest and volume columns.
How are Options Used as Leverage?
After knowing the basics of the Option chain, you can now advance to using this information to hedge investments.
Hedging is a technique used by investors to reduce or eliminate risks in trading. It is done by taking another asset’s position before an asset’s sudden price declines. Since options are highly versatile, they are commonly used for this strategy.
For example, stock traders can easily take an opposing position in the event of a price drop on their own stocks. Hedging works if the two investments you want to hedge have negative correlations. This means that when one investment falls in value, the other should increase in value.
Seasoned investors and traders use hedging only when necessary. They usually do it when the cost of doing so is justified by the reduced risk. Most of the time, they ignore this technique completely because of the costs involved. This is why hedging is more popular among traders who focus on gaining profits out of short and medium-term price fluctuations.
Hedging can be used as part of an overall strategy specific to the goals that you want to achieve. Experienced option traders use it to some degree but they carefully weigh their decisions. After all, option trading capitalizes on your attitude towards risks. Make sure to weigh the downside risks of your options carefully.
What Can You Do to Boost your Options Trading?
Like other assets, options are bought and sold through online or retail brokers. However, if you know how to manage your own portfolio, you can just refer to your trusted trading platforms.
Constant monitoring of your investments can go a long way. This is why you need to choose a trusted trading platform. Some of the factors you need to consider include its competitiveness and customer service. You may refer to this list of the best online trading platforms to get you started. For trading platforms specific to Options, go to this list.
Although Options trading seems too different from trading stocks and other indices, there are still a lot of good case practices that you can adopt. Trading has always been filled with risks and returns so you need to be equipped with the right tools and resources.
To gain a better understanding of Options, refer to this best-selling book by Lawrence McMillan. “Options as a Strategic Investment” has everything you need to know about Options investment. Its latest edition (5th ed.) encompasses all the latest trading vehicles and outlines different strategic opportunities for managing Options investments.
You can also subscribe to information channels like podcasts to hear the stories directly from experienced traders. Since it can be hard to grasp technical information all at once, you can always refer to other people’s lessons. Here are some of the best investment podcasts that might interest you.
To remind you of your investments, it’s also good to subscribe to regular information channels like an email newsletter. Nowadays, there are several quality investment newsletters you can subscribe to.
Options trading may be overwhelming at first but knowing the essentials can help you identify the best ways forward. Since it is a derivative, you should always aim to amplify your gains and not your losses. Be conscious of the several trading strategies you can use to boost your investments. Lastly, learn the language of options chains so you could always make an informed decision in all of your investments.