Options Trading: Pros & Cons
Options are financial derivatives that give the buyer the right but not the obligation to buy or sell underlying assets at a stated price before the expiration of the options contract. A critical part of the derivative market, more than 80% of derivative trading happens in the options market. The remaining trades occur in the futures market. Although options trading offers more strategic freedom than buying or selling stocks, there are specific pros and cons of options trading that a trader must be aware of prior to trading in the options market. Let us quickly review the pros and cons of trading options.
Pros:
- Lower Margin Commitment: If an investor trades in a stock, the investor must buy the stock at the stock price. To buy a stock price, one must pay the trading amount of the strike price. However, for options trading, you only need to pay a small premium and trading commission charges, thus lowering your financial commitments.
- Higher Possible Return: If you have chosen the right strike price, the returns on options trading would be much higher comparatively.
- Lower Risk: The risk in options is predefined. Should you have made a wrong judgment in selecting the strike price and put/call, the maximum loss shall be the upfront committed amount, which is already very low.
- Fixing Stock Price: Only the options market allows to conveniently fix the stock price, which freezes the amount to sell or buy his stock, shares, or other securities.
- Options Strategy Variations: There are multitudes of diversified options strategies. Different trades can be combined to create a strategic position with the help of call and put options of different expiries and strike prices.
Cons:
- Higher Loss to Sellers: In contrast to an options holder (or buyer), the options seller is more prone to misfortune, much more than the cost of the agreement. Keep in mind that when an investor opts for a put or call option, the person is committed to purchasing or selling shares at a fixed price within the agreement’s timespan regardless of whether the cost is favorable or not.
- Limited Timeframe: Each options contract has a date of expiry, be it monthly or weekly
- Lower Liquidity: It makes it difficult to enter and exit from trades in the options market due to rarely experiencing fluctuations.
- Brokerage Charges: Options trading is more expensive than stock trading or futures trading.
- Time-decay: There is a decrease in the prices of the premiums to be paid as the contract reaches its expiry. This is irrespective of the movement or lack of movement in the underlying.
For a layman, it is difficult to get a hang of options trading so you need to be careful. Options can be bought and sold and each situation has its own advantages and drawbacks.