Why trade with Options instead of Shares

In a bid to become a successful trader I have tried pretty much every financial instrument in my life. Futures,Warrants,Shares,Bonds,ETFs etc. If these instruments could play music I would definitely be a one man band !

There are two main reasons why options have become the tool of choice for me.

Time.

Time can play an important role when making a strategic decision about a share. With options,you can literally sell time and make money from it.

For example, if you think a share will go up, sure, go ahead and buy the share. But what happens if your research leads you to believe that the share will go nowhere. How can you profit from that ? This is where options come in

Imagine the following scenario. Company X has had an OK year. It has told the market that the results will be OK this year and the share price fell a little and is trading at $20. It expects to do better next year though. It has a good balance sheet with very little debt and no real skeletons in its cupboard and pays a decent slightly above average dividend.

There is no real reason to buy the share but no reason to sell it either and the results are due out in 3 months time. What can you do ?

If the company has tradable options, you can sell (write) a 20 put option for say $2 that will expire in 3 months time. This means the broker will buy an option from you and in return give you some money. Each option is worth 100 shares so selling 1 contract would give you $200. The real bonus is that if the share price remains at $20 or goes up, you get to keep all the money. If the share price falls, then you must give back some or all of the money depending on how far it falls. Your breakeven point is $18

What I like to do is find these really good shares, wait until they or the market has a bad day and then sell the option. If you sell the option when the share price goes down, you get more money for it.

Of course, I am making it sound simple for demonstration purposes but there is merit in investigating this furrther. The key to being successful with options is to understand (i.e. have a strong view) on the share, index or commodity on which you are betting.

Oh yes, I mentioned two reasons didn’t I. Well, if you are interested you will just have to come back next time and read the second reason !!