Every coin has two sides – so make your investments. For instance, if you are investing in the real estate industry – there is the benefit of investing for a longer term and bigger money. But the hard part about this is that not everyone can invest in the real estate industry because it is extremely expensive, and not everyone has that much surplus. The same applies to various others too. In the case of bonds or government-associated investments, the risks are zero, but the rewards are less. In the case of stocks and shares, the rewards are high, but so are the risks. That is why you need to know both sides of every investment that you plan on making.
In the same way, you would have to consider the same methodology with your options investments. If you are thinking about option investments – it is only right that you know both sides of this story. This piece here is going to speak about the perks and also the risks that are involved when it comes to option trading in the stock market.
What are the Pros of Option Trading
Let’s first look at the best side of things. Here are pros when it comes to option trading:-
It is cost-effective –
Options provide enormous leverage potential. A trader or investor can obtain options positions that are equivalent to stock positions at a significantly lesser margin. For example, an investor must pay Rs. 16000 to purchase 200 shares of a stock at a price of Rs. 80 based on a Nifty realty share price he recently found. However, if he were to buy call options with the same weightage, the premium would be roughly Rs 4000. So we can have a good picture of how cost-effective our solutions are.
It has lower risks –
Although having options is riskier than owning equities, there are situations when options are used to prevent risk. Options are often used to hedge positions. The risk with options is specified because the maximum loss is limited to the premium paid to purchase the option.
The potential for high return –
The returns on options trading would be significantly bigger than the returns on cash purchases of stocks. As a result – of the strike is picked correctly, the option pays the same profit as a conventional stock purchase. Since we are obtaining alternatives with smaller margins and the same profitability, the percentage return would be substantially larger in comparison.
It has more strategy –
There are additional options trading ways that are available in the options market. With the utilization of call and put options with varying expiries and strike prices – the trades could be combined to form a strategic position.
Investors can fix the price –
Options contracts, akin to placing goods on layaway, allow investors to freeze the stock price at a specified dollar amount for a set length of time. It assures that investors will be able to purchase or sell the stock at a striking price at any minute before the option contract expires, depending on the type of option utilized.
Cons of Option Trading
As already mentioned, every coin has two sides – and so does options trading. There are downsides to everything we do in life, and in this matter, it is only a matter if you are willing to fight these downsides for the benefits of the investment. Here are the cons when it comes to option investing:-
It has a higher commission –
Trading options is much more expensive than trading futures or stocks. However – there are also bargain brokers that allow traders to trade with lesser commissions. However, most full-service brokers charge greater costs for trading options.
It is complicated –
Before you begin trading in options, you should familiarize yourself with and follow a series of sophisticated rules. As a result, it’s advised to avoid options trading until you’ve honed your trading skills and understand the majority of market dynamics. This is critical since the huge leverage in options trading can quickly deplete your funds if a trade goes against you.
Limited time –
Options trading seeks to profit from short-term market changes that occur within days, weeks, or months. As a result – you need to choose the optimum moment to buy an options agreement and the ideal time to sell, exercise, or walk away from one before it expires. However, determining this is frequently challenging due to the limited time frame in which you must make this decision.
Options contracts will not be available for all stocks listed on exchanges. This makes it harder for a trader to use options methods to hedge his position.
Time decay –
When trading options, time decay is a bad thing. Regardless of underlying movement, the value of your option premium declines by a certain percentage each day.
Additional costs –
Some options trading techniques (such as selling call options on stocks you do not already own) necessitate the establishment of a margin account, which is essentially a line of credit that serves as collateral in the event that the deal goes against the investor. Each brokerage business has various minimum requirements for creating a margin account, and the amount and interest rate will be determined by the quantity of cash and securities in the account. Interest rates on margin loans normally vary from the low single digits to the low double digits.
Unlimited Losses –
Unlike the option buyer (or holder), an option seller (writer) can sustain losses much in excess of the contract price. Remember that when an investor writes a put or call option, he or she is compelled to purchase or sell shares at a stated price within the time frame of the contract, even when the price is unfavorable (and there is no limit to how high a stock price can increase).
Your portfolio needs to consist of different elements – this is when you won’t be putting all of your eggs in one single basket. Also, it is a great way to grow and expand your returns from the stock market. But, make sure you know both the sides (pros and cons) of the story before you do.