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Options Trading - Advantages and Disadvantages

What is Options Trading?

An option is simply granting someone the right to buy or sell something in the future. In the case of Dow index futures options, when someone buys a Dow call option they are buying the right to purchase that underlying Dow future at a specific price, known as the "strike price," at a future point in time, known as the "expiration date." When an investor buys a put, they are essentially selling the market; a call essentially buys the market. Likewise, selling a put essentially buys the market; selling a call essentially sells the market.

In order to receive the opportunity to buy an option on this future, investors pay a "premium." If the market does not reach the strike price of the option, then that option will expire worthless on the expiration date. If the market does reach the strike price of the option on the expiration date, then the investor will be assigned the underlying future at that strike price.

Advantages of Options Trading

Flexibility. Options can be used in a wide variety of strategies, from conservative to high-risk, and can be tailored to more expectations than simply "the stock will go up" or "the stock will go down."

Leverage. An investor can gain leverage in a stock without committing to a trade.

Limited Risk. Risk is limited to the option premium (except when writing options for a security that is not already owned).

Hedging. Options allow investors to protect their positions against price fluctuations when it is not desirable to alter the underlying positon.

Disadvantages of Options Trading

Costs. The costs of trading options (including both commissions and the bid/ask spread) is significantly higher on a percentage basis than trading the underlying stock, and these costs can drastically eat into any profits.

Liquidity. With the vast array of different strike prices available, some will suffer from very low liquidity making trading difficult.

Complexity. Options are very complex and require a great deal of observation and maintenance.

Time decay. The time-sensitive nature of options leads to the result that most options expire worthless. This only applies to those traders that purchase options - those selling collect the premium but with:

Unlimited Risk. Some option positions, such as writing uncovered options, are accompanied by unlimited risk.

Overall Options present a good opportunity to formulate plans which can take advantage of volatility in underlying markets as well as price direction. However for most traders the disadvantages are significant and online futures trading is usually a better option.

Tim Wreford runs Online Futures Trading, a website that provides information and resources for traders. Tim also provides a free day trading system, the results of which are updated daily on the site.

In The News:

Trump is a 'clown', says Iran's supreme leader in rare public address
Fri, 17 Jan 2020 09:00:00 +0000
Iran's Supreme Leader Ayatollah Ali Khamenei has said European nations including the UK "cannot be trusted" but Tehran is not against negotiating with anyone - except the US.

Will pressure on Iran spark more aggression or pull it back to talks?
Fri, 17 Jan 2020 17:58:00 +0000
In the complex and opaque politics of Iran, this week's Friday prayers in the capital Tehran was one of those moments which provides clues on the country's strength, its direction and the confidence of its leadership.

Ukraine president rejects resignation of PM caught on tape criticising him
Fri, 17 Jan 2020 15:09:00 +0000
Ukraine's prime minister offered to resign after an audio recording suggested he had criticised the president - but his offer was rejected.

Magaluf cracks down on pub crawls with new booze law
Fri, 17 Jan 2020 16:35:00 +0000
Party-goers and bars in three of Spain's top tourist hotspots could face fines of up to £510,000 after authorities introduced new laws to crack down on binge-drinking.

East Africa hit by worst locust swarms in 25 years
Fri, 17 Jan 2020 15:53:00 +0000
The most serious outbreak of locusts in 25 years is spreading across East Africa with a single swarm covering an area one-and-a-half times the size of Greater London.



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