How Can an Option Help My Stock Position?
Sponsored Content—There is a tendency to see investment tools in isolation. Securities. Fixed income. Commodities. Foreign exchange. Some people even see derivative instruments as separate tools. There is a strong case to be made, however, that options are complementary to an underlying asset position.
In a nutshell, options can help change a risk profile. They can help enhance returns, protect against a downward move, or give increased (or decreased) exposure to a specific group of stocks.
Impact on returns
The covered call is a well-known and popular strategy. See http://www.optionseducation.org/strategies_advanced_concepts/strategies/covered_call.html
The investor is holding a stock. She believes that the price will be neutral to mildly bullish. She writes a call option at a strike price (also known as an exercise price) slightly above the current market price (i.e. out-of-the-money). She hopes that at expiration the price of the underlying stock will be between the current market price and the strike price of the call option sold.
There is risk associated with writing a call option. The stock that is held and the option is written against may fall sharply in value. In this case the investor suffers that loss, which is offset to some extent by the premium that she has received. The other risk is that the stock that is held rises sharply in value and the call option that was written is now exercised, limiting the ability to participate in the rally. In this case it may make sense to buy back the call option sold (at a loss to the investor), so that the investor can benefit from any further rises in the stock.
Limiting your risk
The stock market is said to be a mixture of fear and greed.