Objectives of Option Trading
The objectives of the option trades are as varied as there are option strategies. Options can be used to take positions that are extremely bullish, extremely bearish, or anywhere in between. Options can be used to limit risk, hedge against loss, or speculate.
Stock holders can purchase a protective put to hedge against losses from a declining stock. If the stock prices rises the trader will reap unlimited gains while losing only the premium paid for the put. If the stock declines the gains in the put will offset the losses in the stock, which will protect against large losses.
Covered call writers can realize supplemental returns on stock holdings by selling rights their stock positions. This strategy can provide additional income versus simply holding the stock, but does not protect against losses if the stock price falls.
Options can be used to speculate. Traders with a strong bullish sentiment can buy calls, and strongly bearish traders can buy puts. These positions generally have lower probability of return than stock transactions but limit losses with theoretically unlimited gains.
A trader that wishes to take a long position in a stock but lacks the capital to purchase the stock may opt to purchase options instead. This form of leverage places a large amount of an account's assets at risk.
Complex option strategies consist of combined positions of more than one option. They can be used to profit from volatile markets, or profit from flat markets, or lock in positions. Complex option strategies are covered in Chapter 5.