Why bother? Isn't owning stock good enough?

Owning stock gives you part of the ownership of a company. That is a great way to participate in the growth of the business. One problem is that the stock market has been flat for the last ten years. There have been many ups and downs, but the level now, 1050 on the S&P 500, is where the index was ten years ago. The next few years may be slow as well as we get rid of debt in the banks and on our credit cards.

So we have to look for other ways to make money in the market. Options can help.

Insurance

Options can help to lessen the risk of owning stock. That is the insurance aspect of options used by fund managers and business owners when they introduce a new product. Friends of mine at Citibank told me that they were pricing a collar for Bill Gates when a new version of Windows was about to be introduced. Managers will buy puts when they buy a new position for their fund.

Income

Many investors are introduced to options by selling calls on stock that they already own. This is called writing covered calls. This strategy increases income for the investor and smooths out his returns, which is valuable. No one likes riding a stock market roller coaster.

Then there are options-only income strategies like selling puts secured by cash (equivalent to writing covered calls discussed above), selling spreads, butterflies, the names are exotic and the possible combinations are endless. That is part of the reason investors shy away from options, there is too much choice.

Speculation

The leverage in options is what initially attracts speculators to options. An example of this, definitely not a recommendation, is to look at IBM September 120 calls. The stock is trading right now for $118 per share. To buy 100 shares would cost $11,800 in a cash account and half that in a margin account. To buy the 120 call would cost $0.50 per share or $50 for one call which gives the right to buy 100 shares at $120. If this week, IBM rises to 120, the call will be worth $130. That is a profit of $80 on the initial $50 investment. That is a very high return, though very unlikely to happen. So IBM rose $2 per share, or 1.7% and the option rose $80 or 160% in a week. That is the type of return options speculators are looking for.

All three aspects have value done correctly. It takes a little time to lean how to use options. Once you do, you have a flexible and powerful instrument in your hands.