Options Trading- What Are The Benefits & Risks Of It?
Options trading is a little more complicated than the simple process of buying and selling shares. It also offers more strategic and financial leeway to an investor.
Trading in options can help an investor protect himself against portfolio losses, buy and sell stocks at better prices than in the open market, increase the returns on new and existing positions, and lower the risks posed by the prevailing market conditions.
An investor should understand what is Demat account and what are the benefits and risks of options trading to maximize his gains.
Benefits of Options Trading
There are several positives of Options trading. These include:
- Lower financial commitment than stock trading: An investor has to pay a much lower price to buy an options lot than what he has to pay to purchase shares outright. His out-of-pocket investment for the same amount of shares is much less than an investor who purchases shares outright, but he will earn the same percentage of profit if the trade goes his way.
- The downside for options buyers is limited: When an investor buys a put or call option, he is not obliged to carry out the trade. If the trade does not go in his favor, and his assumptions of time and the direction of the stock trajectory go wrong, the losses he incurs are limited to the trading fees and the amount he paid for the contract.
- Built-in flexibility for options traders: Before the expiry of an options contract, a trader can deploy several strategic moves, such as:
- Carry out the options trading, and buy shares to add to the investment portfolio.
- Carry out the option, and buy and then sell some or all of the shares.
- Sell ‘in the money options trading contract to another investor who wants to buy it.
- Have the chance of making back the money he spent on ‘the money options trading by selling it to an investor who wants to buy it.
- Ability to fix the stock price: An investor can freeze the stock price for a specific period under the options trading contract. An options investor can buy or sell the stock at the strike price until the contract expires.
Risks of Option Trading
When you find out the procedure to open a Demat account and trade in options, you should know the risks associated with options trading.
- Exposure to unlimited losses for sellers: Opposite to the option buyer, an options trading seller can incur huge losses, which may be higher than the contract’s price. There is no limit to how high a stock’s price can rise, and when an options trader writes a put or call, he has to buy or sell shares at a specific price before the contract expires, even if the price is not in his favor.
- Limited time frame: An options Trading trader has only days, weeks, or months to make the contract pay off. He capitalizes on near-term price movement, for which, he should make accurate assumptions about the correct time to buy the options contract and the correct time to exercise, sell or walk away before the contract’s expiry. An options trader does not have years for his investing thesis to play out.
- Requirements to trade in options: Not all traders can trade in options. A trader who wants to trade in options has to apply for it with his brokerage house. The brokers make inquiries about the financial standing, and the trader’s experience and understanding of the risks associated with options trading. Based on it, the broker decides the scope of options trading for an investor.
Option Trading Strategy
Options trading is a type of derivative contract trading where an investor has the option to purchase or sell a security at a future date. Option Trading buyers have to pay a premium for the privilege offered by options.
Accumulation of wealth is one of the main objectives of options trading. For a beginner in the stock market with a Demat account, applying options strategies is profitable.
Based on the type of trader, options trading strategy also varies. Understanding the risk associated with investment is essential while implementing an options trading strategy. Even an investor who is not willing to take a high risk in the stock market can earn high returns through options trading.
Trading in options can be beneficial, but the trader must have in-depth knowledge of a company’s business and intrinsic value.