Sunday, February 10, 2013

Advantages and risks in options trading


  • Ö  It is important to understand both the advantages
    and risks involved in trading options before you decide to include options as part of your trading or investment strategy.

  • Ö  A risk for a buyer of an option can often translate into an advantage for the seller of the option.

  • Ö  The main advantages from trading options are: ˜ risk management
    ˜ speculation
    ˜ leverage

    ˜ diversification
    ˜ income generation.
  • Ö  Options can provide an investor with the ability to manage risks on their current portfolio by creating a hedge against a potential adverse movement in the market price of their current share holdings.
  • Ö  Options provide another financial instrument that can be used by traders to generate short-term profits on the stock marke

    • Ö  Options can provide the buyer with the advantage of leverage. This gives them exposure to a similar profit or loss if they had invested in the underlying stock at its full value, for only a fraction of the market price of the underlying stock.
    • Ö  As options cost only a fraction of the price of the underlying security, you can gain exposure to a large range of stocks with a relatively small outlay compared with investing in those stocks directly.
    • Ö  Premiums from selling options can provide a means of income generation for a savvy option trader.

    • Ö  The main risks involved in trading options are: ˜ market risk
      ˜ risk of expiring worthless
      ˜ risk due to leverage

      ˜ potential for unlimited losses ˜ risk of margin calls
      ˜ liquidity risk.

    • Ö  Like all financial investments, there is the risk that the market price will move in a direction that results in a loss.
    • Ö  All options have a limited life determined by the expiry date. As a buyer of options, if the market price of the underlying security does not move sufficiently in your direction before the expiry date, your option may expire worthless.
    • Ö  Leverage can magnify your losses as well as your profits.
    • Ö  As a seller of uncovered call options, you are exposed to
      the potential of unlimited losses. 

      • Ö  As a seller of put options, you are exposed to losses equal to the value of the underlying security at the strike price of the option.
      • Ö  As a seller of options, you are required to provide a margin and may be exposed to margin calls that need to be met within a short time frame (often 24 hours).
      • Ö  Lack of liquidity in the options markets, particularly in times of high price volatility, may make it difficult to close or exit an option position. 
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