The Advantages Of Financial Risk Trading Options Over Stocks

the advantages of trading optionsStocks have been likened to playing a game of checkers, where options are compared more to a game of chess. Thinking strategy and steps ahead. Options provide tremendous opportunities and flexibility to profit for traders, investors, and institutions alike.

Option and stock traders can learn to apply a few basic strategies which are offered by the options market, that better assesses risk in the markets. This places the trader in a much more favorable position to profit with less capital outlay or risk.

In the financial markets, there are trillions of dollars worth of shares which are bought and sold on a daily basis on the various major exchanges around the world. On any given day, traders and investors participate in the purest form of capitalism, this by placing their capital at risk by buying or selling shares in any of the major global markets, this in the pursuit of gain.

Yet, there’s another way of speculation which is trading options, which can be far superior than trading stocks of a given company. An option is a derivative on an underlying security which gives the right, but not the obligation to purchase the security at a set price.

Options offer different “strike” prices and expiration dates, which allows for tremendous leverage. Each option controls up to 100 shares of the stock in a particular company.

The Advantages Of Options
One advantage is leverage. Leverage is the ability to use a small amount of capital to control a bigger asset. Similar to real estate, where a small down payment allows the buyer to control a large piece of property, options allows the trader to control up to 100 shares of stock. This is called the option’s “premium,” which is the cost to control the security.

Options are superior to stocks in terms of leverage. A stock trader speculates that ABS stock is set to rally higher, and is currently trading at $50 a share. The trader then decides to purchase 100 shares of the stock with a cash outlay of $5,000.

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A few weeks later, ABS stock rallies as predicted to $60 a share and the trader decides to sell the stock. The profit would be $1000 for a 20% return. Not a bad way to make an easy living provided everything goes as planned.

An options trader speculates the same scenario in ABS stock. It has a $50 strike price with a $2 premium. The total capital outlay would be $200 for controlling the same number of stock ($2 X 100 shares = $200).

ABS stock then rallies to $60. The options trader sells his $50 strike option for $1200, which is a 500% return. This the power of leverage when trading options.

Basic Options Trading
Another advantage is that an options trader is able to generate income by using credit spreads. If they see that ABS stock is within a trading range and is hovering above support at $50 a share, they can then trade a credit spread, this by creating what’s known as a Bull Put Spread.

The trader sells the current month’s $50 “put” option and then pockets the premium. They then purchases the current month’s $45 “put” option for insurance, this in case the stock plummets unexpectedly.

The trader then allows the option to reach their expiration dates. What’s collected is the difference between the premium received for selling the $50 “put” option, along with the cost of purchasing the $45 “put” option.

ABS stock can rally up or stay around $50 and the position would be profitable. If it drops below $50, equal to the cost of the premium which was received, then the position would break even. The only time the position would lose money is if it declines below the breakeven point.

Most option traders will specialize in just one or two types of option trade scenarios, and are able to generate steady returns of 10% to 90% per position on a consistent basis.

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Advantages Of Trading The Options Market
What options gives the trader is the ability to short stocks without the restrictions associated with actually short selling the stock. Once you short a stock with the anticipation that it’ll go down in price, you have a much larger cash outlay versus buying a put option.

The stock trader also needs to pay interest on the stock that they “borrowed” to short, along with paying the dividends back that the stock might pay, this during the time they hold it.

With put options, what you do is avoid all that, plus you can make quicker returns sooner, this because stocks will tend to generally fall two times quicker than they rise.

Also, if there’s rumors that a stock will miss its earning projections, you can profit quicker by trading options, this by playing the negative earning release provided it’s in the right market environment.

The reason being that stocks can often gap down by 50% or more on “bad” news releases. That translates into a huge profit for the smart options trader without tying up a lot of capital.

Options A Much Better Option
The biggest advantage of trading options is that the trader just loses the premium that they paid for the option, which preserves capital.

If a stock happens to suddenly gap up or down unexpectedly, and the trader happens to be on the wrong side of that trade, the options trader risks/loses just a small amount of their capital. For the stock trader, they could potentially lose half or in some cases all of their trading capital in just one bad trade.

There are additional advantages and strategies when trading options, this provided that strict discipline is used, and the trader is prepared to learn and apply them properly.

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