Pros and Cons of Options Trading

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The Risks and Rewards of Options Trading

Before you begin trading options, you need to understand the difference between a stock and a stock option. Brokerages require traders to be informed and educated about this type of investment before they can begin trading, so it’s important to learn about the process in advance. You’ll always encounter risk and reward with investments; however, you’ll experience a greater risk and the possibility for a greater reward when you’re trading a stock option.

Stocks are sold in shares, and traders often purchase and sell multiple shares in a single transaction. If you own a share of stock, you actually have a small ownership stake in the company. As a result, you can make money when the company does well. Some companies pay investors through declared dividends, but you can also sell your stock for a profit if its value reaches a higher price than the amount you paid for it.

However, a stock option works differently. Owning an option does not give you any portion of ownership in the company. Instead, you have the right to either buy or sell the company’s stock at a predetermined price. Each stock option has an expiration date, so you have to be cautious to exercise it in time. If the stock’s value rises above the purchase price determined in your option, you can still choose to purchase it at the lower price. Then, you can sell it immediately to someone else in order to make a profit. Similarly, if a stock’s value decreases from the original price set in the option, you can sell it for the higher price.

The Benefits You’ll Receive with a Stock Option

If you make informed trading choices and the market performs well, you can make a significant profit through options trading. A small movement in stock prices can equate to a large payoff if you own a stock option instead of a traditional stock. High payoffs in a short time attract many investors to the world of stock option trading.

The Risks You Need to Consider

Of course, anything that brings such high rewards possesses some inherent risk. Because options are one of the riskiest investment strategies around, brokerages take great steps to ensure that only educated investors are allowed to trade. You can gain money quickly with a stock option, but you can lose it just as fast. Additionally, you always need to pay close attention to the expiration date and specific terms of your option. Failing to meet the option’s terms could cause you to lose everything you invested.

Getting Started

If you have investment experience and you’re interested in trading options, you still need to be approved by your broker before getting started. You might also need to get a margin account in order to begin trading. Brokers can be held responsible for substantial costs if inexperienced traders default on trades made through margin accounts, so your broker will require you to fill out an application and agreement before you can complete any transactions. However, after you’ve studied the material, received approval and learned more about stock option trading strategies, you should be ready to begin trading and working toward successful investments.