Nowadays, many investors' portfolios include investments such as mutual funds , stocks and bonds. But the variety of securities you have at your disposal does not end there.
Another type of security, known as options , presents a world of opportunity to sophisticated investors who understand both the practical uses and inherent risks associated with this asset class.
The power of options lies in their versatility, and their ability to interact with traditional assets such as individual stocks. They enable you to adapt or adjust your position according to many market situations that may arise. For example, options can be used as an effective hedge against a declining stock market to limit downside losses. Options can be put to use for speculative purposes or to be exceedingly conservative, as you want. Using options is therefore best described as part of a larger strategy of investing.
This functional versatility, however, does not come without its costs. Options are complex securities and can be extremely risky if used improperly. This is why, when trading options with a broker, you'll often come across a disclaimer like the following:. Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss.
Only invest with risk capital. Options belong to the larger group of securities known as derivatives. This word has come to be associated with excessive risk taking and having the ability crash economies. That perception, however, is broadly overblown. Put this way, wine is a derivative of grapes; ketchup is a derivative of tomatoes. Options are derivatives of financial securities — their value depends on the price of some other asset.
That is all derivative means, and there are many different types of securities that fall under the name derivatives, including futures , forwards , swaps of which there are many types , and mortgage backed securities. In the crisis , it was mortgage backed securities and a particular type of swap that caused trouble. Options were largely blameless. Properly knowing how options work, and how to use them appropriately can give you a real advantage in the market.
If the speculative nature of options doesn't fit your style, no problem — you can use options without speculating. Even if you decide never to use options, however, it is important to understand how companies that you are investing in use them.
Whether it is to hedge the risk of foreign-exchange transactions or to give employees ownership in the form of stock options, most multi-nationals today use options in some form or another. This tutorial will introduce you to the fundamentals of options.
Keep in mind that most options traders have many years of experience, so don't expect to be an expert immediately after reading this tutorial. If you aren't familiar with how the stock market works, you might want to check out the Stock Basics tutorial first.
Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance.
Become a day trader. How Options Work Options Basics: Types Of Options Options Basics: Options Spreads Options Basics: Options Risks Options Basics: This is why, when trading options with a broker, you'll often come across a disclaimer like the following: Options are valued in a variety of different ways.
Learn about how options are priced with this tutorial. A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price. Stocks are not the only securities underlying options.
Learn more about stock options, including some basic terminology and the source of profits. Learning to understand the language of options chains will help you become a more informed trader.
Identify the differences between federal and private student loans, and what Sallie Mae does and doesn't do nowadays. Before investing in a company with multiple share classes, be sure to learn the difference between them. Understand how prepaid expenses are recorded on a company's financial statements. Learn why a prepaid expense would be considered Learn how the five C's of credit affect new credit application decisions, and understand how a lender analyzes each aspect Get Free Newsletters Newsletters.More...