3 Advantages of Stock Options

Many inexperienced traders balk at options, viewing them as risky wagers that expire worthless more often than not. However, stock options are a viable and relatively inexpensive way to accrue profit while limiting exposure to potential losses. Below, we'll explore a few of the reasons that an options contract can be a smarter investment than simply purchasing shares of a stock. (Click here for a primer on put options, and here for a primer on call options.)

Leverage

Perhaps the greatest benefit of stock options is leverage, or the principle of wagering relatively small amounts of money in an attempt to accrue profits far larger than the original bet. By nature, options require much less capital upfront than purchasing a comparable amount of stock. A standard option contract represents 100 underlying shares of equity, and is usually available for cents on the dollar compared to the cost of actually buying 100 shares on the Street. The logic is simple -- doubling a $300 option investment is a piece of cake compared to doubling a $3,000 stock investment. So, by utilizing stock options, investors can attain the large percentage gains that they desire while utilizing a smaller portion of their overall capital.

Plus, option traders can generate a quicker profit compared to buy-and-hold stock traders. With stock options, even a modest 10% change in the price of a security can result in 100% profits or higher.

Diminished Risk

Conservative investors are often intimidated by the idea of trading options. But even the most conservative traders can appreciate one of the greatest advantages of stock options -- diminished risk. By purchasing put and call options, an investor actually risks much less initial capital than if they were to simply trade the stock the old-fashioned way. While you do risk the possibility of losing your entire initial investment, there is no one that wouldn't rather take a 100% loss on a $250 option contract over a 100% loss on $2,500 worth of shares, if the stock's price plummets to zero.

Multiple Strategies

Finally, stock options allow traders to take advantage of a myriad of investing techniques -- some more complicated than others. Old-school investing is essentially done in two ways: bullishly (long positions) or bearishly (short positions). On the other hand, stock options allow traders to employ a multitude of effective strategies that can capitalize on more than just a simple uptick or downturn in a stock's price.

Calls and puts can be used to profit off any type of price action -- higher, lower, or even stagnation. In fact, traders can implement strategies to capitalize on a major move in either direction, or to protect long or short positions in their portfolio. In fact, some options traders disregard price movement altogether, instead utilizing changes in the implied volatility of options to profit. The sheer amount of available strategies is massive, and we will delve deeper into how they work in future articles.

Leverage, diminished risk, and flexible positioning are just three of the advantages stock options offer over basic investing. For many experienced traders, options are a pivotal aspect of any portfolio, and their uses range from utilitarian to being the crux of a much larger investment scheme. Next week, we will explore how protective puts can be used to guard against losses and protect capital.