The Benefits of Using Options

Options are a dynamic, versatile and robust financial product, that while over 800 years old, has evolved into a complex niche market touching on most traded assets in existence today.

Given our intricate financial markets that pervade the global economy, it comes as no surprise that any opportunity to reduce the cost of investment and maximize returns will be taken full advantage of; it is the investor’s mantra to judiciously allocate resources to obtain the greatest benefit.

This being the case, the option is a useful device to enable entry into a plethora of markets at the fraction of the cost of physical entry. Asset prices the world over are reflective of economic growth and prosperity, and while they will fluctuate over time, invariably, participation is unleveraged and any investment requires considerable amounts of capital to be committed. Alternatively, options on underlying assets are investment opportunities denoted in premium. As such they are priced at a fraction of the underlying asset price; they are derivatives of the underlying asset.

Traditionally it has been accepted that investment requires an initial purchase of an asset, with a subsequent sale when the transaction is realized. These days of course, many markets provide for short selling, a term reflecting a synthetic unrealized sold position as an initiating transaction. Options too, cater for short selling, but it will be found that a seller of any option is accepting the requisite premium in return for an unlimited exposure to the underlying asset. This necessarily is a greater risk than that of a mere purchase of the underlying asset, as most assets cannot travel not travel into a negative price. Therefore, the risk of asset purchase is limited to the purchase price, whereas a seller of an option is obligated to honor the holder’s exercise of that option at any time prior to expiry.

However, options can be utilized to offer less risk to the investor. Particularly if initiated by the purchase of options, the risk will always be limited to the premium paid for the option, and therefore will be mere fraction of the cost of purchasing the underlying asset.

A feature collateral to this lowered cost of investment that is inherent in option trading is the fact of higher returns on investment (ROI). Given that the investment is lower, options will resemble the underlying asset in priced direction. When prices move with significantly, the option will be found to not only resemble the underlying price direction, but replicate it to an increasing degree. At this point, what was an investment that totaled a fraction of the underlying asset price is now returning the same gains as the underlying. Necessarily, the return on investment (ROI) will be far greater.

Additionally, the underlying asset is invariably offered to investors in a standardized form. The subject matter of the asset is uniform as in the case of any commodity. Options are also standardized but offer a variety of series (terms to expiry), and types (puts & calls), and strike prices (predetermined underlying price). With this kind of diversity afforded the investor, any number of individual scenarios are able to be provide for, limited only by the investor’s creativity and foresight.

 

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