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Investors Have No Shortage of Options
07/02/2012 10:17 am EST
There are profitable option strategies available for conservative and more aggressive investors, says Dan Passarelli, who describes a couple that those from each category can consider.
We're here with Dan Passarelli, and Dan, there's so much talk about options these days, and a lot of times they're misunderstood by investors and traders alike. Tell us a little bit about who options are for, how people can start, depending on whether they're a trader versus an investor.
Options are not necessarily for everyone, but there's a pretty good cross section of the investing public who can use options. Conservative investors can do things like buy a put to protect their portfolio, or an individual stock position, for that matter.
Or, they can generate income on a stock they already have that they think might not rise or fall too much. That income-generating strategy is called a covered call.
So that's what an investor might consider in order to use options pretty conservatively and responsibly.
So the covered call strategy uses low-volatility stocks, the risk-off stocks like utilities that aren't really moving in this kind of market.
And, if they do move, generally it's slightly to the upside as people come in for safety's sake. But you're not really putting your life savings at risk, and you're juicing up a little bit of the returns on some low-yielding stocks.
Exactly, and that's an excellent feature of options is that you can do that. When you think stocks are not going to move a lot, there's a strategy for that, just like you described. When you're afraid that stocks might move a lot, there's a strategy for that-like buying the put to protect the stock.
Then there's a whole host of other strategies for both conservative investors and more aggressive, speculative traders.
Give me a speculative strategy.
For example, instead of going out and buying a stock, a trader can buy a call as a stock substitute.
There are certain advantages and tradeoffs with options. For example, when you buy a stock, if the market goes higher, you can profit; if the market goes lower, you could lose, of course.
But sometimes, something happens in the market where the stock drops a lot, and maybe that's stock-specific, where bad news comes out, bad earnings; or sometimes it's market news, or systematic risk. When that happens, if you own a stock, you stand to potentially lose a lot.
But if you buy a call, you have limited risk, so you can have similar upside potential, but you limit that downside potential because you're only investing a fraction of what you would have if you bought the stock itself.
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