Listed Options – Risk Factors And Reasons To Trade
The world of trading is wide and diverse. The forex market, being the largest globally, is flooded with investors both rookies and veterans who aim to make some profits through trading.
Are unique because they are contracts that allow two parties to agree to sell or buy underlying assets at a specific price and within a specific period.
Risks Involved In Options Trading
- Amplified Losses
Buying stocks or other assets on the forex market can be costly. However, options are a much cheaper form of investment. It requires holders to invest only in a small fraction of the total value of the underlying asset. This is because options are derivatives.
This essentially means that in cases of profits, the value is amplified. The risks are enormous, however, because losses are also amplified if prices don’t move like initially planned. These risks can be averted by a holder because they are not obligated to exercise the option. The contract writers on the other hand are obligated to buy or sell regardless of whether this will lead to a profit or loss. The losses they can incur may by far exceed the premium they gained in selling the contract.
- Requirements For Investors
Options are technically a cheaper investment than buying stocks or other securities directly. But simply having the money to begin investing is only part of the requirement.
Listed options are traded on the exchange. This means that there are specific requirements that traders must follow before they can invest.
- Applications must first be sent through a broker.
- The broker will assess the potential trader, assessing the financial ability of the investor, the level of experience the investor has in terms of trading, and even the level of the investor’s understanding of the risks involved in options trading.
- Once the assessment is made, the investor will be permitted to trade. Permissions to trade different types of options will differ based on the investor and the findings of the assessment.
Why Trade Listed Options
Trading options, like many other forms of trading, can be complicated sometimes. It requires time researching, analyzing, and proper understanding. Despite this, there are many reasons why investors would consider trading listed options.
Limited Risks – All forms of trading have some level of risk, options aren’t any different. However, holders of stocks have the privilege of choosing whether to exercise the option contract or not. This means that holders can use options as a form of speculation and choose not to exercise the option if prices move against their predictions. In cases where the option is not exercised and left to expire, all the trader will have lost is the premium used to purchase the contract in the first place. Despite the direction the prices move, the effects are generally not adverse on the trader because of their ability to opt-out of the contract.
Buying Time – When traders aren’t sure what step to take next, options are a good way to trade. Options can essentially protect the value of underlying assets through hedging. Also, a holder could potentially make a profit if prices move in their favor. If the prices movements aren’t favorable, the holder can opt-out of the contract, losing only the premium which was initially paid.
Speculating – Options can be used to speculate. This is where investors predict how prices in the market will change. With the trading position open, holders could potentially gain a profit from predicted price movements. They may also seek to gain a profit from an increase in premiums that caused changes in market prices. They can achieve this by selling open positions at a higher premium and gaining the difference as profit.
Leverage – Options are derivatives, this means that investors only pay a fraction of the actual value of the underlying securities. This means there are fewer barriers to entry as a trader. The other advantage is profit margins are large because the trade is based on the full value of the underlying assets. This would also be true in the reverse, losses are amplified. A holder can opt-out of the contract to avoid making huge losses.
Options are a good form of trade but investors must first understand the different uses and also analyze the risks involved before investing.