Question: Why Trade Options?

Answer: For Leverage & Increased ROI (Return on Investment)
If you buy 1000 shares of xyz stock trading at $20.00, it would cost you $20,000 ($20 x 1000 shares).

If you trade a January option on 1000 shares of xyz stock and the option is trading at $1.50, it would cost you ($1.50 x 10 contracts x 100 shares) $1,500. Each option contract has 100 shares.

It would be $18,500 cheaper than buying the stock! You have $18,500 to invest in other stocks or options.

The reason to trade options is leverage. You can leverage your money to make a higher return on your investment (ROI). Instead of putting all your eggs in one basket, you can spread the risk among many investments.

If xyz stock moves up $1.00, you made $21.00 x 1000 = $21,000 – $20,000 initial investment or $1,000. The ROI would be $1000 profit/ $20,000 investment = 5%.
If the option moves $.50 when the stock moves $1.00, you made $.50 x10x100 = $500. The ROI would be $500 profit/$1500 investment = 33%. Most investors would prefer a 33% return over a 5% return.

Leverage increases your ROI (return on investment).

Leverage allows you to spread the risk among several investments instead of pinning all your hopes on one investment.

Options (puts and calls) allow you to spread the risk over many investments. You buy calls when you think the stock price will rise and you buy puts when you think the stock price will fall. Remember - Call up, put down. You make money in a rising or falling market.

If you want to get fancy and protect your position, you can use an option trading strategy by placing an option spread call or put order. You can buy one side and sell the other side thus reducing your cost. You are using other people’s money to leverage your investment.

For instance, if the April 20 call is trading for 4.35 and the April 25 call is trading for 2.26, you could buy the April 20 call for 4.35 and sell the April 25 call for 2.26. Your cost would be 4.35 debit – 2.26 credit = 2.09 per share. Each contract has 100 shares, so 10 contracts would be 1000 shares. $2.09 x 10 contracts x 100 shares = $ 2090. You control 1000 shares for $2090 not $20,000! It is almost 1/10 the cost.

If you just bought the April 20 call it would cost you $4.35 debit x 10 contracts x 100 shares = $4350 but by using an option spread you lowered your entry price and saved $2260 ($4350 - $2090)!

In the stock market today, options are a resource for balancing your risk.

Option trading is about using less money to accomplish the same goal.

Option spreads are about using less money and protecting your position.