You may be wondering why would an investor want to get involved with complicated options, when they could just go out and buy or sell the underlying equity? There are a number of reasons such as:
- An investor can profit on changes in an equities market price without ever having to actually put up the money to buy the equity. The premium to buy an option is a fraction of the cost of buying the equity outright.
- When an investor buys options instead of equity, the investor stands to earn more per dollar invested - options have "leverage."
- Except in the case of selling uncovered calls or puts, risk is limited. In buying options, risk is limited to the premium paid for the option - no matter how much the actual stock price moves adversely in relation to the strike price.
- Options are very time sensitive investments. An options contract is for a short period - generally a few months. The buyer of an option could lose his or her entire investment even with a correct prediction about the direction and magnitude of a particular price change if the price change does not occur in the relevant time period (i.e., before the option expires).
- Some investors are more comfortable with a longer term investment generating ongoing income - a "buy and hold" investment strategy.
- Options are less tangible than some other investments. Stocks offer certificates, as do bank Certificates of Deposit, but an option is a "book-entry" only investment without a paper certificate of ownership.