Option trading provides an official contract between the buyer and seller and offers the former with the right to execute or not execute a particular deal. The seller on the hand who is also referred to as the underwriters have the obligation that corresponds to the deal.
Options are basically of two types i.e., call and put both of which have a different role to play and can be advantageous under different circumstances. On one hand, the call option provides the buyer the option to purchase an asset at a given strike price. In this, the investors expect to earn profits when the stock prices rise. The put option, on the other hand, provides the buyers with the ultimate right to sell the stock at the given strike price on or before the maturity date. Investors make the profit in this case when the stock prices fall down.
There are several advantages associated with the options trading each of which are explained below. Starting with the benefits, here are some of the points that you can consider in its favor.
Hedging: Investors can easily manage risk leverage with the help of options as the amount of investment made is quite low than usual. Investors get great exposure by paying considerably premium in this case.
Risk-reward payoff: With options trading, you can an opportunity to earn unlimited profits and restricted losses over the entire period.
Low investment: Options allow you to earn large profits from the small investment.
Flexible Strategy: You get to have access to unique strategies where you can take the advantage of market characteristics such as time delay and volatility which help during the fluctuating market.
The best part thing about engaging in options trading is that you can protect your stock portfolio with the help of it. Here is how it is possible:
By selling a covered call: This is one of the best strategies to earn great profits on a given number of stocks. Although it comes with its own risks, yet it protects you from major losses.
By buying put option: Buying the put option will put you in profit when the market low. These more or less act as an insurance policy but with a certain deductible amount. One of the benefits of purchasing the put is that the risk associated in it is limited and you would stay protected for a major portion of time even during the crisis.
By initiating collars: Collar combines the best of the methods which are mentioned above and are one of the best ways for protecting the stock portfolio from acquiring a loss.
By replacing stocks with options: Last but not least, the stock replacement strategy is somewhat riskier than the ones mentioned above and involve replacing the stocks with call options. The chosen stocks are then exposed to limited losses during the time of market decline.
These strategies are primarily designed to deal with different market scenarios and providing the investors with the best solution for their invested money. These, however, do not come with the guarantee of assured profit but can be employed with the limited risk associated with them. It is advised that you develop an understanding of the option strategy before you jump on to this market and along with that practicing in the paper-trading account would prove to be a great learning experience for any beginner.
Well, this was all about how options play an essential role in developing your portfolio and how you can employ different strategies to gain good returns on your investment over the subsequent years.