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Why Options Are a Great Trading Vehicle
11/12/2009 12:01 am EST
I get a lot of questions from people who want to trade options, but they're worried about whether their portfolio is big enough, or whether they should leave their capital alone for now because they need the money to live on.
And while committing money to any type of position can be stress-inducing, the ability to risk a lot less and position yourself to make the same-size (or bigger) returns is a gift you shouldn't dismiss lightly. In fact, the options markets are designed for any size portfolio -- you don't need a large account to make yours perform like one!
Options Are Hot
The options markets have been around since 1973. Things were much different then -- can you believe that put options didn't even debut until several years later? Imagine not having the ability to use puts to protect your stocks or to make money while the markets crumbled and stocks tanked!
Thankfully, things have changed a great deal in the past few decades, as investing, and particularly, investing in options – to play stocks, indexes, currencies, futures, commodities, and exchange-traded funds (ETFs) to the upside and the downside -- has become much more mainstream.
In fact, the Options Industry Council (OIC) reported that, for the month of August, options trading volume is up nearly 9% year-over-year, with average daily trading volume coming in at 13.6 million contracts changing hands (compared to 12.5 million last year).
Unlike the "regular" markets, where a certain number of stocks are issued for each company (with the exception of special circumstances like stock splits), the options markets expand to include everyone who wants to be a part of them.
You've got to love a marketplace where there are enough opportunities – and profits -- to go around for everybody!
Options for Everyone
How is it that the options markets have been around for over 35 years, and many people are only now just discovering them?
The good news is it's never too late. Even if you're starting out with a small amount of money, whether you're new to the game or your portfolio's gone through the wringer, and even if you have a good-sized account and want to manage it more-efficiently, options are for everybody.
It has only been in recent years that options started receiving proper recognition as a powerful tool to add to your investment arsenal. When options first started, they were supposed to be, and were built to be, the perfect hedge – a security that was going to allow you to actually take risk out of your portfolio.
But because of their leverage – which allows you to control a same-sized stock position but for far less cost, and therefore, risk -- options started being used as a gambling instrument. And it was because of this that they got a bad rap.
Now, people are starting to recognize options for what they truly are and their true power, which is that of a risk-management tool.
Additionally, you have access to better education, better information, and more knowledgeable brokers who really understand the options markets. We also have something called the Internet, so you can access your account and actually take charge of it the moment you're ready to do so.
Even More Reasons to Use Options
Options trading volumes are on the rise for a number of reasons, and the marketplace will continue growing to accommodate everyone who wants to trade them.
First off, we have multiple options exchanges – the Amex, Boston, Chicago, International, NASDAQ, NYSE, and Philadelphia exchanges -- that are competing against each other to provide the biggest, thickest, best market they can to compete for your order flow.
This gives you, as the individual investor, an advantage, as your broker has to get you the best-possible price for your orders. If people want your order flow, they're going to find you nice, tight markets, and that's going to make it easier for you to make your trades.
Secondly, many options are now being traded in penny spreads – down from nickels and dimes from just a couple of years ago. When option spreads are trading in pennies, this automatically tightens the markets. Just because options are inexpensive compared to actually buying stocks, that doesn't mean you should overpay to enter your positions. And as more options become available to be traded in pennies, you have an opportunity to save money before you make even more.
Another big shift has occurred in that margin is becoming available for options investors. Options were always a cash-only business. But now that the SEC has finally figured out the true value of options as a hedging tool, it is starting to change margin requirements when you use options. Things aren't quite where they need to be yet, but they've taken some major steps recently, in margining options properly. And I think they're going to get there pretty soon.
It's an exciting time to be a participant in the options markets, whether you're looking to protect your current holdings, replace your stocks entirely, and/or add new positions to take advantage of events like earnings seasons.
By Ron Ianieri
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