8 pros and cons of options trading

There are different ways of investing your hard-earned money, and one great way besides mutual funds or stocks is options trading. Options, also referred to as equity or stock options, are contracts that give a buyer and seller the right but not commitment to buy or sell specific shares, stocks, or any other securities at a fixed price before their expiry date.

Option trading differs from standard stock trading in that it provides you with greater strategic freedom, albeit it’s a bit more complicated to master. Before playing your hands at options trading, it’s best to learn about this investment strategy’s possible pros and cons. Without further ado, below is a detailed look at everything you need to know.

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Pros Of Option Trading

You should start by looking at the benefits of options trading to decide whether it’s an appropriate investment strategy. They include:

1. Lower Upfront Financial Commitment

You’ll read from every trading post that options trading is highly profitable due to its considerable leveraging power. This means you’ll spend a lot less purchasing an option compared to what you’ll need to pay to buy shares outright. But despite spending less money, your potential return will be much greater compared to your original investment.

2. Greater Flexibility When Trading

The main reason to trade options is that it offers you greater flexibility when trading. Thanks to this, you’ll be able to better hedge against your existing investments. These different trading strategies are available at your disposal, and this includes:

  • Exercise option to buy shares and consequently sell all or some of them.
  • Exercise option to buy shares and add them into your existing portfolio.
  • Sell your profit-making options to another trader.
  • Possibly earn back some money by selling a loss-making option to another investor before the contract’s expiry.

3. Reduced Risk

While options trading is often deemed to be risky, this doesn’t always have to be the case because you can design trading strategies that limit your exposure to making a loss such as hedging. So, if your trades don’t go your way, your loss-making is restricted only to the contract payment and applicable trading fees.

4. Greater Possible Returns

Another advantage of options trading is that it boosts your potential returns compared to purchasing shares. This is attained because options are typically available at a lower margin but still yield you a greater potential return on your investment. You can also gauge the market to see whether it can generate you a return greater than the earlier pre-determined price, leaving it to run to earn maximum returns.

5. Fix A Stock Price

Options trading lets you freeze the number of shares, stocks, or other securities you’re buying or selling. This means you can choose a specific price for a certain duration that aligns well with your trading requirements. No other trading strategy offers you this freedom you enjoy with options trading to buy or sell a stock or other security before its expiration date.

Cons Of Options Trading

Regardless of how good any trading strategy might appear to be, it certainly will have a couple of risks and downsides. Below are some of the cons associated with options trading:

  1. It’s Complicated

Options trading usually has a certain set of complex rules that you must understand and adhere to before you start trading. Because of this, it’s best to avoid options trading until you’ve perfected your trading skills and have an excellent grasp of how most of the market dynamics. This is especially important because the high leverage in options trading can quickly deplete your funds when a trade goes against you.

  1. Traders Must Meet Specific Requirements

Not everyone can trade options because there are a certain set of requirements that you must meet to be approved by a broker. This will entail answering numerous questions asked by your broker designed to gauge your investing experience, understand your financial means, and ensure you know the risks of options trading. After that, you’ll be required to deposit at least USD$2,000 into your brokerage account to start trading options.

  1. Limited Time

Options trading looks to take advantage of short-term price movements that happen within days, weeks, or months to make a profit. Therefore, you need to pick the perfect time to buy an options agreement and pick the best time to sell, exercise, or walk away from one before its expiry. But determining this is often complicated due to the shorter duration within which you must make this decision.

Takeaway

Thanks to the heightened technological advancements and innovations, it’s now easier to access a broader range of financial products such as options trading. But while this investment strategy might be profitable, you shouldn’t rush into it without first learning the potential pros and cons. Reading this article has enlightened you about the possible upsides and pitfalls before you go ahead with this trading strategy.