Advantages of Options

Employed correctly, options can:

  • Enhance performance
  • Create greater investment opportunities and exposure
  • Protect against downside

At their grass roots level, options provide the following important advantages:

Risk Management

Put options allow you to hedge or insure against a possible fall in the value of shares you hold.

Time to Decide

By taking a call option, the purchase price for the underlying shares is locked in. This gives the call option holder until the expiry date to decide whether or not to exercise the option and buy the shares. Likewise the taker of a put option has time to decide whether or not to sell the shares on or prior to the expiry date.

Speculation & Directional Options Trading

The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them. If you expect the market to rise, you may decide to buy call options. If you expect a fall, you may decide to buy put options. Either way you can sell the option prior to expiry to take a profit or limit a loss.

Leverage

Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly. However, leverage usually involves more risks than a direct investment in the underlying shares. Trading in stock options can allow you to benefit from a change in the price of the share without having to pay the full price of the share. The following example helps illustrate how leverage can work for you. The table below compares the purchase of 1 call option and 1,000 shares. The higher percentage return from the option demonstrates how leverage can work.

  Option Stock
Bought on October 15 $380 $4000
Sold on December 15 $670 $4500
Profit $290 $500

Return on investment
(not annualised)

76.3% 12.5%

Diversification

Options can allow you to build a diversified portfolio for a lower initial outlay than purchasing shares directly.

Income generation

You can earn extra income over and above dividends by writing Call Options against your shares, including shares bought using a margin lending facility. By writing an option you receive the option premium up front. While you get to keep the option premium, there is a possibility that you could be exercised against and have to deliver your shares at the exercise price. It is important that you balance the advantages of investing in options with the risks before making any decisions.