6.
Their advantages and disadvantages are outlined below.
Feature Advantage Disadvantage Effect on Holder/Writer
Cost Options are an inexpensive way to gain access to the underlying investment without having to buy stock As a form of insurance, an option contract may expire worthless. This risk increases the greater the extent to which the option is out of the money and the shorter the time until expiration. Holder may be disadvantaged due to expiry. Writer would be advantaged as s/he need not make delivery once the option has expired.
Leverage Options enable investors to stump up less money and obtain additional gain. Investors should realize that options\' leverage can impact performance on the down side as well. Writers of naked calls are exposed to unlimited risk.
Marketability Option terms trade on an exchange and as such are standardized. Regulatory intervention can prevent exercise which may not be desirable. Both parties to an options transaction benefit from standardized and enforceable terms.
Hedging Options may be used to limit losses. The investor may end up being incorrect as to the direction and timing of a stock\'s price and may implement a less than perfect hedge. Both the holder and the writer may be (dis)advantaged depending upon which side of the trade they assume and the ultimate direction of the underlying security.
Return enhancement Options may be used to enhance a portfolio\'s return. The investor may end up being incorrect as to the direction and timing of a stock\'s price, rendering the attempt at enhanced portfolio return worthless. Both the holder and the writer may be (dis)advantaged depending upon which side of the trade they assume and the ultimate direction of the underlying security.
Diversification One can replicate an actual stock portfolio with the options on those very stocks. Diversification cannot eliminate systematic risk.
Regulation Terms of listed options are regulated. Restrictions upon exercise may occur by regulatory fiat (OCC, SEC, court, other regulatory agency). While in some cases necessary, regulatory fiat can disrupt what may be a profitable trade, affecting holder and writer alike.

7. Drivers of option valuation include the volatility of the underlying investment upon which it is based; the time left until expiration, the level of interest rates and the extent to which the option is either in- or out-of-the-money.

8. Option holder's choices at expiration-exercise the option, allow it to expire or sell it prior to the expiration date.


Tax Rules, LEAPS and Futures

Related Articles
  1. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  2. Trading

    Options Pricing

    Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
  3. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  4. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  5. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  6. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
Frequently Asked Questions
  1. How do you calculate r-squared in Excel?

    Calculate R-squared in Microsoft Excel by creating two data ranges to correlate. Use the Correlation formula to correlate ...
  2. What is the Difference Between International Monetary Fund and the World Bank?

    Learn about the International Monetary Fund and the World Bank and how they are differentiated by their respective functions ...
  3. Where Did the Bull and Bear Market Get Their Names?

    The terms bull and bear are used to describe general actions and attitudes, or sentiment, either of an individual (bear and ...
  4. What's the difference between Google's GOOG and GOOGL stock tickers?

    Learn the difference between Google's GOOG and GOOGL ticker symbols. Splitting shares into classes prevents management from ...
Trading Center