Options trading is an alternative way of investing your money. Apart from buying shares or bonds, you can now invest in options contracts – also known as derivatives – with much less capital. You must understand that these are not “get rich quick” schemes.
They have their risks, just like any other method of making money. However, if done correctly and with careful analysis, you can mitigate these risks to a certain extent.
Options trading is the action of buying and selling puts and calls options. Puts and calls are financial instruments that give the holder of such a contract the right to trade an underlying asset at a prearranged price within a designated time.
To put it simply, you can ‘buy’ contracts to purchase shares of stock by paying some amount upfront (known as the premium), just like buying insurance for something – in this case, your investments. These contracts will only be profitable if their value increases due to a rise in the share prices.
It’s an easier way to engage in the stock market
As a new investor, an options contract is the easiest and quickest way for you to get involved in stocks. As you can buy shares without having enough money to purchase them, it allows people who don’t have a lot of capital, as students or young professionals invest in stocks. Instead of having only $1-$2K per share on margin accounts (which also has very high-interest rates), each option contract paid at least $500. This amount may seem small, but the return on investment (ROI) is enormous.
It allows you to participate in potential future growth stocks
As mentioned above, options are relatively cheap compared to shares. It allows investors who do not have a lot of capital to buy some exposure for potentially significant returns. You can buy calls or puts on risky companies but may provide strong returns – like small-cap stocks – before they are listed on any exchange.
Furthermore, with calls and puts, you’re also ‘locking’ yourself into good profits if your prediction is correct – as opposed to buying shares that would require you to sell them at whatever market price is available when it’s time to cash out. With this strategy, you don’t need to worry about the share price falling after you purchase them – or even having a pessimistic outlook. Have a look at the Saxo markets to get an idea of market prices of different options.
You can get decent returns on investments
Although it may seem like purchasing regular shares will bring much better returns due to their high ROI compared to options trading, there are some types of options that can bring a decent return. When you purchase calls, you’re essentially purchasing the stock at a lower rate than it will be sold for at a later date – just like regular shares.
However, unlike shares, these contracts are time-limited, so you must consider the day when they come to an end. If your prediction is correct, this will result in handsome returns on your initial investment – considering no one else buys the contract from under you before then.
You don’t have to worry about paying high brokerage fees
Another advantage over buying shares is that there are usually much lower fees associated with trading options contracts than stocks. They don’t only require less capital, but their commissions are also much lower than buying and selling shares.
It is particularly beneficial to investors interested in speculating on smaller companies with high-growth potential – where the risk of failure for both options and stocks is higher.
You can get your money back if your prediction is wrong
As long as you’re confident that you’re making the right decision at the time, purchasing calls allows you to take advantage of an increase in share price. You also won’t have to worry about holding onto these contracts until the expiration date, or worse – being forced to sell them just because they’ve fallen in value.
Once you purchase a call contract, if the price drop severely after days or weeks, you would be able to sell it quickly without incurring any losses.