There's never been a better time to begin learning and trading options. Whether you've traded puts and calls for 20 years or you have no idea what an options contract even is, there are myriad reasons why the time is right to learn about this asset class. Let me give you 10:
. According to the Options Clearing Corporation, total annual options volume increased to 3.3 billion contracts in 2009, up nearly 400% in less than 10 years, and 2010 is likely to be another record year for the options industry. In addition, new options exchanges are sprouting like mushrooms in the spring. This year alone, the BATS Options Exchange made its debut in February and the C2 Options Exchange began taking orders about 10 days ago. The industry is growing because investors are becoming more active in the options market.
. Over recent years, increasing numbers of brokerage firms have warmed up to options trading. Not only are they allowing more customers to trade, but firms are increasing options education and the ability to trade advanced strategies online. If, for example, you want to trade a call spread on your favorite biotech, you can now initiate the trade with one or two mouse clicks and get instant confirmation when your trade has been filled.
. While options are sometimes associated with speculation and risk-taking, the fact is, options are great tools for
risk. A hedge is a position that offsets the potential risk from another position. A put option, for example, can be used to mitigate the risk of holding shares of stock. A put on the
index is a great way to mitigate the risk of holding a stock portfolio.
. Want to play a highflying stock? Afraid to lose your shirt if it crashes? Buying a call option gives you the right to lock in a specific price for a buying a stock. Buying calls is usually a lot cheaper than buying the stock -- that is, it requires less capital. Of course, when trading calls, there is also a greater risk that the call will expire worthless and or that you suffer a big percentage loss. For that reason, speculative activity -- buying puts and calls -- should be limited to a very small percentage of one's overall portfolio.
. Spreads can be used to mitigate some of the risk of straight put- and call-buying. For example, buying a call and selling a call with a higher strike price is called a vertical spread; such a strategy can be used to profit from an upward move in the stock. It's less risky than straight call-buying. In addition, one of the great things about spreads is that the risk-reward profile of the position can be determined ahead of time. The best way to view the risk-reward of a spread is with a payoff chart or risk graph, which are offered at no charge by most options brokers today. Just plug the numbers in and you can find a graph that shows how much you can win, how much you stand to lose.
. Speaking of brokers, most stock brokerage firms allow investors to sell calls against stock, even if they have no experience in options trading. This strategy, known as a buy-write or covered call, is allowed because it is less risky than simply holding stock. For example, if I own a stock, I can sell calls against the position to generate income. If the stock moves higher, the stock will probably get "called away" or sold. Still, by selling calls against my stock, I have lowered the cost basis of owning it and also lowered my risk. The first step to getting started in covered calls or other options strategies is to talk your broker and ask for an options approval account form.
You have choices.
You can trade puts or calls, or both. If you're bullish, you can buy calls. If you're bearish, you can buy puts. If you're not sure, you can buy both and create a position called a straddle. The straddle buyer can make money whether the stock makes a move higher or lower. The key to success is volatility!
. Commissions have been falling in recent years as the competition heats up among options brokers. Very rarely do investors pay $25 or $50 to execute options orders. Some charge just a few dollars per contract.
. Put and call options are derivatives, but they are not the OTC derivatives that are being blamed for the volatility that exacerbated the global financial crisis. Put and call options are listed on nine highly regulated options exchanges and are cleared through the Options Clearing Corporation. The options market is transparent, efficient and growing each year.
! If you like investing and learning about financial markets, the options arena is a fascinating place. This is where you can discover a lot of "smart money" trades, new innovative products like tools for playing volatility, and strategies that can make money whether the market goes up, down or sideways.
Frederic Ruffy is an experienced trader and provides daily commentary and analysis of the options market. He is co-founder of the web site, WhatsTrading.com. His work has also appeared in Futures Magazine, Technical Analysis of Stocks & Commodities, Stock Futures and Options, and Sentiment.
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