Hi Impatient Investors.

This post assumes some knowledge of buying options. It will discuss the risks of buying options and how they can be beneficial to your portfolio. The process of buying options is very similar to selling options.

Options Explanation

Options are contracts, calls and puts. A quick summary is that puts do well for a declining stock while calls do well for an increasing stock. The risks lie in the possible outcomes for both calls and puts.

There are 3 possible outcomes:

1) trade contract for profit or loss,

2) let the option expire worthless (out of the money), you lose the premium paid.

3) when the option is exercised (in the money), for a call that is buying 100 shares, for a put that is selling 100 shares.

Buying Options in Action

Let’s say you are a long term investor, you are buying and holding, going with the swings of the market. Options can amplify those swings or level out your account. In this scenario of a long term investor buying the dip, let’s say along with buying the dip you bought a call in the underlying stock and you were correct. When the stock price rebounds, your call option will increase with greater intensity than the stock (if you bought the right option). On the flip side, buying put options when the stock seems too high could act as insurance in case the price goes down because put options increase in value whenever the underlying stock falls (if you bought the right put option). This is of course over simplistic, this involves timing the market and having a decent understanding of technical analysis.

Theoretical Options Example

Let’s revisit the stock chart from an earlier post, now with added annotations as to when would be the ideal time to buy the options while still staying invested in the underlying stock.

This is the stock chart annotated from yahoo finance. It is very important to remember that hindsight is 2020 but this is shown to imagine the power of options. Ideally, options would reduce the downward pressure and magnify the returns all while holding the stock. So the stock provides dividends and growth while buying and selling options would magnify returns and lessen the blows of downward movements. Ideally, you would want to mirror the movement of the stock but many things have to be aligned just right.

Are Buying Options Worth the Risk?

Impatient investors, stock options are directly up your ally, or maybe not, as they are risky. Risk tolerance is personal, and buying options isn’t for everyone. Options can lead to 100% loss because options have an expiration date. Or the worst that can happen is to buy a call option (the right but not obligation to buy 100 shares), if you allow the option to expire in the money, then you will be forced to buy 100 shares of the underlying stock at the price. In the example above, you would need thousands of dollars. Options are contracts, and those contracts can be traded, so when it increases, you can sell for a profit. Often for more percentage gain than the stock itself. In summary, puts increase in value when a stock price decrease and a call increases in value when a stock price increase.

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