Stock trading is a field that’s becoming more and more volatile. That’s why it’s important to learn how to use buying strategies such as buying calls and buying puts. With buying calls, there is speculation that the market or stock will go up. On the other hand, buying puts is used by traders who believe that the stocks or market is going down. The benefit of these two strategies is that an investor uses a small amount of money to generate huge returns. Here are the benefits of options trading.
Reduced Costs
Options trading is extremely attractive for small pocket traders. Taking a position in options can significantly minimize your costs. Suppose you wish to purchase 10,000 shares of the ABC Company, which is presently trading at Rs 130 level. The company’s Rs 130 call option is quoting Rs 5 and its lot size is rated at 6000. If you decide to purchase stocks, your total investment would be (130 x 10,000) = 1,300,000.
But if you opt to go the options way, you’ll have to buy 2 lots and your investment would be (5 x 2 x 6000) = Rs 60,000. What this means is that the cost of your investment in options trading is only 3 to 4 percent of the total investment required in stock trading. For more information click here.
Limited Risks
With options trading, there’s limited risk to the investments you make. If you buy shares of company ABC and on the following day, the firm announces its intentions to close one of its subsidiaries and thereafter the stock opens 15 percent below your entry price. The stock price now falls to Rs 110.50, whilst the 130 call option becomes zero. In terms of stock, you’d incur a whopping loss of Rs 234,000; whereas in options you’d lose Rs 60,000, which is way less than the one-loss incurred in stock trading.
Higher Potential Returns
Trading in options gives you a chance to experience higher percentage returns, which are hard to find in stocks. Assuming that company ABC’s delta is 0.80, which implies that options price will increase by 80 percent of the stock price. In case stock grows to Rs13, you’ll earn a 10 percent return.
Whilst your options position will gain up to Rs 10.40 on the Rs 5 investment, it means that your return on investment is approximately 208 percent, which is much greater than the return on stock trading.
Increased Flexibility
Options trading often gives you the flexibility to alter strategies depending on different market conditions. Of course, there are numerous strategies for all types of markets, whether sideways, bullish, or bearish. You can always switch strategies according to different market conditions.
Hedging
Everyone who trades in the penny stock market gets exposed to certain risks. In case any adverse market movements occur, hedging simply safeguards your trading positions from suffering severe losses. For instance, if you picked ABC’s company stock for Rs 100 six months ago and now it’s trading at Rs 125; it means that you’re earning about 25 percent on your investment. But because of the result season, you notice that the markets might soon enter a turbulent phase, which means that you could end up losing all the cash you earned during this period. In this case, you can simply hedge your position by purchasing an ATM put option, which will significantly limit your risks during adverse market situations.
Earnings From Existing Portfolios
If you’re a long-term investor who’d like to earn more returns or lower the cost of your existing portfolios, you may want to opt for covered call writing. Consider writing a call option of the stocks you hold as this could give you some income on your investment. If you own 7,000 shares at a certain company, which you purchased for Rs 1300 and this stock is now bringing you substantial returns, you’ll want to hold them further.
Key Takeaway
Typically, options trading requires less financial commitment than stock trading. The cost of purchasing an option is much lower than an investor would need to pay to buy shares outright.
Options investors often pay less out-of-pocket cash to play within the same sandbox, and if the trade goes well, they’ll just benefit in the same way as the investors who opted for stocks.
There’s a limited risk for option buyers. Purchasing a put or call option doesn’t oblige you to follow through on the business. If the assumptions you make regarding the time frame, as well as direction of a stock’s trajectory, aren’t correct, your losses are particularly limited to whatever you paid for your contract and trading fees. Nonetheless, there could be some downsides for option sellers.
Options provide in-built flexibility for traders. And before an options contract expires, traders have numerous strategic moves they can execute, including:
- Exercising the option and buying the shares to incorporate into their portfolio
- Exercising the option, purchasing the shares and then selling some or all of them
- Selling the options contract to other investors before it expires
Options also allow investors to fix stock prices. Plus, options contracts make it possible for investors to freeze the stock price at a particular dollar amount for a given time. Regardless of the type of option utilized, it guarantees that investors will have the chance to buy or sell stocks at the strike price whenever they feel like as long as the option contract hasn’t expired.
The Options Clearing Corporation offers a detailed rundown of the all the characteristics as well as risks of standardized options plus an overview of the American federal income rules which affect those investing in financial products such as options trading.
The Bottom Line
To decide whether to purchase, sell, or hold a given stock for the long-term, you should have a detailed understanding of the company’s business and have a clear sense of the direction in which the asset is heading. As an options investor, you should be hyper-aware of these aspects.
Options success requires traders to have deep know-how of the company’s intrinsic value as well as a solid thesis about how the business has been affected by factors such as internal operations, macroeconomic impacts, and market competition.
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