If you’re considering implementing option trading strategies into your overall investment portfolio, you may want to evaluate the overall advantages and risks associated with utilizing this investment vehicle. For many individual traders, incorporating option trading strategies can have tremendous upside potential with limited risk if you have a comprehensive understanding of the principles associated with options. Let’s take a look at some of the key benefits and risks of option trading strategies.
Benefits
Leverage: The ability to use option trading strategies to leverage small amounts of trading capital permits the trader to engage in significant positions without committing excessive funds from within the larger portfolio.
Limited downside risk: With most option trading strategies, the goal is not only to leverage small amounts of trading capital, but to also hedge against downside risk while leaving upside potential unrestricted.
Hedging: Many option trading strategies can permit a trader to hedge against unwanted market price fluctuations in a current portfolio position.
Flexibility: Overall, there area great number of various option trading strategies which may be implemented for nearly any market environment or equity position. From basic hedging strategies to complex trade setups, individual investors can use options for many different purposes.
Disadvantages
Complexity: For the individual investor, option trading strategies may seem overly complex and therefore not worth the time and effort required to understand their utilization. Although many strategies are very basic in nature, some of the more advanced trades require dedicated study, precise setup, and level thinking.
Costs: Generally, the commissions associated with executing option trading strategies are much higher than standard equity trading fees. This can be somewhat cost prohibitive for the average passive investor and even for an active trader, these costs can certainly eat into profits.
Liquidity issues: With some options which are thinly traded, such as those which are well out of the money due to strike price and exercise date, liquidity can be a major issue.
Unlimited risk: There are a number of option trading strategies which carry with them unlimited downside risk potential. One such trade is writing uncovered options and any of these strategies should only be executed by a skilled and seasoned trader.
If you’re interested in implementing option trading strategies into your portfolio, take some time to thoroughly evaluate the advantages and risks associated with any strategy you may potentially execute.