Benefits and risks of investing in options
The flexibility options provide in allowing you to potentially profit from both rising and falling markets make options powerful products. However, options do carry risks. In particular, when writing options you can open yourself up to the risk of potentially unlimited losses.
Options trading can be an effective way of generating wealth, whether as part of a wider investment strategy or as a standalone technique. Their uses in both rising and falling markets can make them powerful products. Like any investment, options have risks you need to understand. You should seek independent advice from a professional adviser before investing.
Options are classed as either call (the right to buy) or put (the right to sell).
You can generate wealth from rising and falling markets. You could take a call option to profit from a rising market – locking in a buy price now and benefiting from the underlying security’s capital growth over time. On the other hand, you could take a put option to benefit from a falling market, by locking in a high sale price before values fall.
Different option strategies involve different levels of risk, so you have the freedom to choose a strategy that suits your own needs and investment objectives. For example, taking options can involve relatively low-risk, depending on the investment strategy you adopt. If you take options and the underlying securities do not behave as you expect, you can simply allow them to expire, losing no more than the initial premium you paid for the option.
Some investors use Call options to defer the decision to buy or sell shares, a strategy that allows you to see how the shares behave before making a commitment either way. Again, if you buy a Call option and decide not to exercise it, the most you can lose is the initial premium – normally only a fraction of the total share price.
Writing options against shares you already own can provide additional income. You will generate income upfront from the premium, however, you will be obliged to deliver the shares at the agreed price if the option is exercised.
Options can be used to offset potential falls in share prices by taking put options giving you the right to sell your shares at a pre-set price for the life of the option, no matter how low the share price may drop.
Options do carry risks. In particular, when writing options you can open yourself up to the risk of potentially unlimited losses.
Writing options can be considerably riskier than taking options as even though your premium is fixed there is the potential to incur losses greater than that amount. For example, if the market moves against your position, your losses can escalate quickly. Writing call options if you don’t own the underlying securities is particularly risky, as you will have to provide the underlying securities if you are exercised against.
Options have an expiry date, and as such decrease in value over time. The value decrease rate accelerates the closer you get to the expiry date. Additionally, market factors such as interest rates and market volatility can affect the value of an option.
If you are writing options, ASX may require you to provide extra security to ensure that you can meet your obligations if your options are exercised. This will require you to pay additional funds to maintain your position. If you cannot do this, your broker may close out your position and you will be liable for any resulting losses.
Options trading strategies can be complex especially if you need to take offsetting positions. Doing this can be a risk, in itself, if you do not fully understand this strategy. Before trading options you should ensure you fully understand options and their risks, and consult your broker.
This booklet explains options, how they work and what they can be used for.
Both courses have 10 modules with each module taking 20-25 minutes to complete
Complete suite of online courses from beginner to advanced options education plus trading courses on technical analysis and trading systems. (Free Sign-Up)
Two monthly trading webinars designed for you to ask questions live while presenters walk through an introduction to options and advanced options trading. (Free Sign-Up)
Challenge your knowledge of options and sharpen your trading skills.
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