Why Use Options?

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Everyone wants to get a high return with minimum risk. Isn’t it? But, in the stock market, many of us assume that higher risk implies a higher gain. Well, this is not always right. Options can work for you if you know how to use options to get a higher return.

As you know that many investors and traders use options to participate in the stock market. They prefer options over other derivatives.

Now, the question comes in the mind that why most investors and traders want to use options?

And the answer is very simple, Options give you the opportunity to earn more with minimum risk, earn not only in the uptrend of the market but in the downtrend of the market also.

Also Read: How Options Work?

Why Use Options – Top Reasons

Here we are going to discuss some important points which will clarify why use options in the first place?

1. Options Give Right to Buy or Sell

Options are securities which have strict terms and conditions. The option gives you right, but not an obligation to buy or sell an underlying asset with a fixed price on or before a specified date. Your right to exercise expires after the last date of expiry.

We can take an example to make it clear for you!

Suppose, you want to buy a car of ₹5 Lakhs, but you don’t have the money for the next 3 months. In this condition, what you will do? You will try to convince the owner to wait for you to buy the car within three months, and for this, you pay a token amount of ₹50,000.

With this token amount in place, the owner will be obliged to wait for 3 months for you to get the rest of the money and complete the deal. However, it remains your call whether to buy the car after 3 months or not (although, in this case, you most likely will).


2. Market participation with minimum Risk:

In order to understand why traders use options, you need to know that if you want to participate in the stock market with minimum risk, you can use options.

Options need a proper understanding of the market movement and if you have reasonable expertise in that, an option is the best tool for you to enter in the stock market.

Here, buying call options and put options allow you to make the investment by just paying a minimum amount to the option seller called the option’s premium.

If till the options expiration your market anticipation doesn’t work, all you will lose is the premium only.


3. Versatility:

The benefit of options is not limited to the profit generation only in the uptrend of the market. But, here you can generate income from both directions of the market, whether it goes up or down. Due to the versatility of the options, you can generate income when the market goes down or one-sided.

If you enter into an option, either you will be a buyer or seller. If you are a holder of the call option you will have the right to buy.

And if you are a holder of the put option, you are obligated to buy or sell.

There are two main reasons to use options from the point of view of a buyer.

A. Betting on the market movement (Speculation):

Buying options contract means you are betting or speculating on market movements. It requires deep knowledge of the financial market, then only you can bet with high a probability of success.

To get success in the options trading you must have the idea that in which direction market is expected to move. Not only this but must also be right about the price change and the time frame for this to happen.

If you are buying an option means you are allowed to use leverage. Leverage allows you to pay a small amount of the price of share like ₹10 of ₹500. It means leveraging offers you to earn a huge amount of profit with the minimum investment.

B. Insurance policy for stocks (Hedging):

Just like we take the insurance policy for our life, house, car, business etc. Options is an insurance policy for stocks.

This strategy of insurance for stocks called hedging.

If you buy a call option and want to limit your losses. This strategy can be useful to you. Hedging will help you to restrict your losses with minimum cost, while you can earn maximum profit.


4. To attract employees of a Company:

An option is not famous among market players only. But, it is one of the methods of many companies to reward, retain and compensate their employees. Many companies offer Options to their employees. They offer the call options mainly.

Actually, a call option gives their employees the right to buy a stock with a fixed price on a specified date. This option is similar to regular option as the holder of both the options has right but not an obligation to buy.

Options offered by the company is the contract between the employer and employees. While a normal option is a contract between two parties who are totally unknown to each other.


How to use Options – Summary

Here is a quick summary of what are the best ways to use options in your trades and get consistent profits into your kitty:

  • Options give you the right to buy or sell an underlying asset at a fixed price under a specified period.
  • Helps in the investor’s portfolio and stock market risk mitigation.
  • Options help to earn maximum profit with minimum risk.
  • It is like an insurance policy of stocks.
  • It works not only in the uptrend of the market but, also in the downtrend and one-sided market situation.
  • Employer of the company use options to attract their employees also.

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More on Stock Market Education:

If you are looking to learn more about Options trading or stock market investments in general, here are a few reference links for you:

 

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