By Melody

Today we will be talking about the advantages and disadvantages of options. Even though many of you already have experience trading options, it is still good to know if there is any other way to utilize options trading to your advantage. 

Let's start with the advantages of options trading

The advantages of options mainly include two parts:

Part 1. Making more money

Generally, there are two ways to make money trading options.

Firstly, options can act as a leverage, it lets you gain big with a relatively small amount of money invested. (Of course, more reward implies more risk so please do not get too excited!)

Let's pick a random stock and an option related to demonstrate this:

Here is a screenshot of NIO yesterday. It closed at $42.35 a share and was up 12.3%.

If I bought 100shares when the market opened, I would have invested $38.78(opening price)*100shares=$3,878.

If I had sold them when the market close, I would have gotten $42.35*100shares=$4,235.

My profit would be $4,235-$3,878=$357, which was 12.3% of my total investment.

Now let's see if we invested in options instead, what would happen.

Since our purpose is to demonstrate the difference between investing in options or the underlying stock, I picked a random option as an example.

If I bought 1 contract (which stands for 100 shares of the underlying) of the above options at the opening of the market, it would cost me $1.43(opening price)*100=$143.

And just like the previous example, if I had sold this options contract when the market close, I would have gotten $3.15*100=$315.

My profit would be $315-$143=$172, which was 111.41% of my total investment.

Now let's compare the two examples above.

If we had gotten 2 options contracts, we would have made around the same amount of dollars we made by investing in the underlying stock. This means by investing $286 in the option above, we would have made the same amount of money as if we invested $3,878 in the underlying stock.

Secondly, options can provide a steady stream of income.

For example, if I currently hold 100 shares of NIO in my portfolio, and I believe that NIO stock prices will not go up in the near future(either consolidation or decline). I could sell 1 call contract of NIO and earn the call option premium. 

Part 2. Hedging risk

In options trading, we can utilize options combination, which is also called the options strategy, to control or lower the amount of risk we are taking on.

Options strategies will be introduced in detail later. 

A simple example would be the example earlier about selling call options.

If NIO price drops, we would be taking losses since we own 100 shares in our portfolio, but it will be made up by the call option premium that we earned by selling call options of NIO.

Now the disadvantages of options!

The buyer of options can lose 100% of their investment, and the seller of the option can lose up to all the money they have in their account. 

For example, if I bought 1 contract of the NIO call option that we've mentioned before, and the stock did not go as we had predicted, the value of the option that I held will eventually reach $0 as time get closer to the expiration date.

So, the worst outcome is that I lose $143, which is the amount I paid for the option.

However, if I am the seller of the option, this will not be the case. As the stock price swings up and down, my margin will be affected, and once my account balance is lower than the margin needed, I will be receiving a margin call. And if I am unable to add funds to maintain our margin level, I will suffer a margin closeout.

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