The major benefits of options relative to trading stocks or funds are:
- Options require less capital; you'll have fewer total dollars at risk in the market. These leftover dollars can be placed in safe investments such as a money- market fund. Why buy stocks outright when you can “lease” them with options, especially when your expectations are likely to change more frequently in a volatile market?
Buy-and-hold equity investments still have a place for long-term investors, but you can also set aside a small portion of your portfolio to benefit from the more frequent swings that can create even bigger profit opportunities for traders positioned to capitalize on these market swings.
- Options offer profit potential not just when the market rallies, but also when it drops. If you are bearish on the stock market, cash is usually your only alternative. Why should you be correct in your assessment of a down market but not be able to profit from this correct view? With options, you can use both calls and puts to your advantage. With most strategies, risk is limited to the amount paid for the option.
- Other option strategies can be created to profit from any market view. For example, if you expect the market to be flat over the next month, you can seek to profit by selling option premium.
- Options offer far greater leverage than stocks or funds. For investors who are pleased to have called a 10-20% move in a stock, they often could have made 100% or more buying an option on that stock. The concept of leverage is what allows one to put limited dollars at risk but still experience healthy absolute profits.
- Put options are usually a better choice than selling a stock short. Unlike shorting a stock, option purchases do not require a margin account. In addition, a short stock position has theoretically unlimited loss potential (the higher the stock goes, the more a short seller will lose), whereas a put buyer’s maximum loss is capped at the cost of the option.
- Options can hedge stock or fund portfolios without losing the tax advantages available on long-term stock gains. This improves after-tax returns on stock holdings, while still allowing you to protect those stocks during market turbulence.