Options are considered versatile and flexible investment tools. Options were invented as tools to reduce risks. Specifically, they were created to transfer risks from those who wish to avoid excessive risk to those who are willing (for a fee) to accept that risk. Thus, options can be used as insurance documents. However, most beginners in the options world do not recognize this risk-reducing concept and end up using options like gambling. We encourage you to use options as someone who wishes to mitigate risks when investing in the stock market.
Avoiding Risk vs. Speculation
When you buy homeowners insurance, you are making a bet with the insurance company. For a fee, the insurance company guarantees to provide money to replace your home if it is destroyed. You do not expect to win this bet. In fact, you hope the insurance policy ends without being used. However, you buy insurance when you cannot afford to replace your home if something unexpected happens. So you purchase insurance for the peace of mind it provides.
A risk-averse stockholder can do the same. By paying a fee to buy a put option, the stockholder is guaranteed (for the life of the option) that the stock’s value will not drop below a certain price level (the strike price of the option). As with homeowners insurance, time passes, the insurance policy expires, or the option becomes worthless, and the cost of insuring the property is lost. The question that arises for most people is whether that cost is worth the peace of mind it provides. The answer is almost always “yes” when dealing with the home.
The goal of this discussion is to ensure you are aware of this. Option buyers tend to be of two types. Conservative investors who own stocks and aggressive traders who wish to bet on a stock price decline. Selling options is almost always speculative (this is not the time to talk about exceptions) by betting that the stock price will not decline, or at least that it will not decline enough to cause a financial loss.
Covered Calls
To reduce risks when investing, there are several options strategies that should suit your needs, including writing covered calls and selling cash-secured naked options. It should be mentioned that buying options as insurance when you own stocks is not a good option. It is a common choice because investors do not make enough effort to understand options well before making their first options trades.
If you prefer speculation, we encourage you to learn about the risks associated with it. The main point is that you should avoid taking on unlimited risks when it is easy to define the risks with each trade.
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Source: https://www.thebalancemoney.com:443/are-options-for-risk-takers-or-the-risk-averse-2536873
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