Options: Your Advanced Strategy to Hedging the Risks
Every successful investor needs a strategy that hedges the risks of entering the stock market. Options reduce your risks by giving you a conditional right to buy or sell.
What are Options? How Do They Work?
Instead of an actual purchase or sale, an option is the right to buy or sell. Think of reserving the right to buy or sell at a specific price. More importantly, think of how often you’ve tried to enter the market but couldn’t find a buyer or seller at the price you specified. As long as prices hit the mark you set for a given date, you will always have the option of buying or selling at that price. Investors use these contracts because, well, they keep your options open.
Options are only helpful once you realize that you don’t have to incur any losses. With this privilege, there are no obligations, and that’s the key. If prices didn’t hit your mark, simply let the option expire — however, factor in the transaction fee to be paid to the broker. Nothing is entirely free, but since you’re not required to take any actions, options can reduce your risk in all market conditions.
Here are some things to know about how they work:
– A Call:
When you place a call order in, it tells your broker that you’re requesting the right to buy an asset once a price is hit.
– A Put:
A put option is placed in when you’re requesting the privilege of selling an asset at a specific mark.
– An Expiration:
Every stock option expires. You can only buy or sell before an expiration date based on the order type you submitted.
How Do You Hedge Risk with an Option?
You have three factors for hedging risk, as stated above. Essentially, you only need to gauge the cost of your premium as the risk. The hedging power of an option is time. Even if the expiration is hit, you’re never required to make a decision. You have time to wait things out; some option contracts take years to expire. Of course, you can collect profits at any time before those dates arrive.
Originally posted on RagingBull.info.