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

    Income 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.
  2. Trading

    Exploring European Options

    The ability to exercise only on the expiration date is what sets these options apart.
  3. Trading

    Options Pricing

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

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  5. 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 ...
  6. Trading

    Give Yourself More Options With Weekly and Quarterly Options

    Weekly and quarterly options were introduced to give a greater choice of option expirations to investors, and enable them to trade more efficiently.
  7. Trading

    Exploring The World Of Exotic Options

    Exotic options provide investors with new alternatives to manage their portfolio risks and speculate on various market opportunities. The pricing for such instruments is considerably complex, ...
  8. Trading

    What Drives An Option's Price?

    The primary drivers of an option’s price are the underlying stock’s current price, the option’s intrinsic value, its time to expiration and volatility.
  9. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center