Benefits of Trading Options

The options market is extremely fast-paced. Understanding how options trading works can be quite a task for those who are new to it. Unlike the stock or futures trader, an options trader must know more and do more in order to successfully take advantage of the investment features and flexibility options trading can provide.

Knowing the risk and reward potential of each investment position you are considering is essential. Understanding how each position can affect the risk and reward of your overall investment portfolio is key to using options to assist you in successful trading.

Options are contracts based on an underlying asset. They are standardized, financial instruments and are listed on the major United States exchanges as well as in Europe. They enable you to participate in trading a particular market, without the risk and financial investment of actually trading that underlying asset.

You are not just limited to buying, selling, or staying out of the market. Options enable you to customize your financial positions to your specific trading situation as well as to how you believe a particular market's price will change. Options provide a tremendous amount of flexibility to you, particularly because of the many strategies that can be employed to trade options.

Trading options gives you an extra edge in limiting your risk and exposure in several ways. You are able to take advantage of the numerous risk-calculated factors that help you analyze your positions, and identify potentially profitable positions. Some of these factors include using the Greeks such as Delta, Gamma, or Vega, all of which calculate the impact of price movement by the underlying asset on your option position. For more information, see Using the Greeks. You can also profit from the numerous strategies that can be used to trade options. Many of these strategies can be combined and used to adjust your positions when the market is going against you and some positions can be used in conjunction with an existing position you may already have in the underlying asset.

You have leverage when you trade options, particularly if you are the buyer. This is because an option enables you to buy or sell at a fixed price for a specified period of time. If the market moves in your favor before the options contract expires, then you can execute your contract, termed exercising, and profit from the trade. If the market doesn't move in your favor, you can let your options contract expire and the only loss you incur is the price you paid to buy those options contracts. This cost is always much lower than what you would have paid to actually buy the underlying asset.

The majority of option positions you might trade have a known risk. For the buyer, it will always be the price paid for the options contracts. However, risk is unlimited to those traders who write, or sell, an options contract, particularly if they do not currently own enough of the underlying asset to cover the options contracts that they sell. They are at risk when the market goes against their options position.

Trading options can also help protect current holdings in the underlying asset, and provide you with some income from an uncertain position in an underlying asset. You may still take a loss, but you are able to limit your exposure and lessen the risk to your overall portfolio.