Options trading, while being very popular, doesn’t necessarily have the best reputation. Many people associate it with gambling (and the way many people do it definitely is) and claim that it is very risky. While it definitely can be very risky, options trading can actually be less risky than buying shares.
Options trading is when someone trades the option to buy or sell a certain number of shares (one contract is usually 100 shares) of a stock at a particular price at a particular date. If one thinks a stock is going to go up, they buy a call option and if they think it is going to go down, they buy a put option. That’s a simple explanation of a complex thing but that’s the basics.
Let’s say one was going to buy a call option. The premium that option is trading at is $2 a share. The option is for 100 shares so they pay $200 for the options contract that expires in two months. In two months, if the stock went down instead of up, they lose that $200 and the options contract expires worthless. If the stock did go up, they can buy 100 shares of the stock at the strike price of the options contract or sell the contract. That is why options is considered so risky. You can lose the entire initial investment.
Here is why options can actually be less risky than stocks though. Let’s take the same example from the paragraph above. Someone buys a call option on a stock at a $2 premium per share and pays a total of $200. The stock goes down at the expiration date, and they lose $200. Now let’s say instead that they bought 100 shares of the stock instead. If the stock went down by enough, they could actually lose a lot more money than the $200 from the option contract. Options can give investors access to a lot of shares at less downside risk.
Options are definitely not for everyone, but they can be a good addition to one’s portfolio.
Finance by CWT 