Tesla, Apple, and Amazon, to name just a few, are some of the biggest companies traded on the stock exchange. However, many investors have found that instead of trading stocks, it's much better to trade on them through various types of contracts known as options.
The option contract allows for the investor to acquire a right to buy or sell a share at a specific price in the predetermined period of time. For instance, you can buy a call option, which will give you the right to buy the shares of Tesla, while the price of the share rises even higher above the price stated in your option contract. You may also buy a put option, which will allow you to sell the shares of any company at a set price even if the stock falls.
Options give traders a chance to place bets on how the stock will behave. They offer certain benefits which include the ability to generate substantial profits at lower prices than would be needed if you were to buy the stock directly. For example, an investor buying Tesla options can control the behavior of its stock at a much lower cost. If the price of the stock increases, the profit from the option will increase significantly, giving the buyer handsome profits.
However, there is always an element of risk when it comes to the use of options. They are known for being volatile, meaning that any small changes in the stock price might yield a substantial gain or a loss for the holder of the option. If someone is not familiar with the use of options, it can easily turn into a financial trap. It is because options are limited in time – if the stock does not change as expected before the end of the term, the option may expire worthlessly, and all the investment will be lost.
A good illustration of the application of option trading is the trading in the stock of the electric vehicle maker Rivian. Rivian was going public in late 2021 and many believed that it was the future of electric vehicles and could possibly compete with Tesla. Instead of buying stocks of Rivian directly, some investors went for call options hoping that the price of its stock would increase substantially soon after going public.
However, in the period after the IPO, the price of the stock became volatile and did not appreciate as much as investors hoped for. Hence, the call option holders saw that their options were expiring fast without making profits and in fact, the prices of these options were declining. Investors who held options with an expiry date in the far future still had hope, but those with short-term options stood to lose all their investments.
This situation shows the strength as well as the danger of options trading. Those who got it right stood to make huge gains without having to fully invest in stocks. However, others were reminded that, despite the opportunities presented by options, they can be both a blessing and a curse. For beginners, it shows how important it is to know how options work before taking the leap.