Options are one of the hottest investment vehicles in the trading world today. Some traders are looking to speculate, some are merely looking to hedge. In any case, more and more investors are looking to options signals as a way to earn money in an up or a down market.
It wasn’t always this way, though. Options have earned a name for themselves as being risky. Due to their status as securities, they have also been held unfairly responsible for the 2008 financial crisis. It wasn’t necessarily options so much as it was mortgage-backed securities, though.
The Basics
Options signals are broken up into two different categories. A call option is the right to buy, and a put option is the right to sell. It’s important to remember that these agreements signify the right to buy, but not the obligation to do so. Of course, the investor has to pay for this right. Options signals also come with a deadline, called the expiration date.
Let’s look at it with an example. Say an investor acquires an options contract that gives him the right to buy 100 shares of Google at a set price. Then, the price of Google rises. The price of the options contract rises, too. At any point before the expiration date, the investor can purchase the 100 shares of Google. Alternatively, they can sell the contract itself.
It’s important to remember that options are considered wasting assets. The closer they get to their expiration date, the worse the contracts become. This is because the outcome is easier to predict, so it is eventually harder to make money off of them. Shorter contracts are less expensive than their longer counterparts for this reason.
How to use Options Signals
Traders choose to use options signals for multiple reasons. Reasons depend on the long-term goals and the temperament of the trader. Hedging, for instance, uses options trading signals to reduce risk for less cost. The downside of this is that if you are worried your stock investment might go south, it might not be the right stock choice.
Options aren’t just used for hedging, either. They can be very effective when it comes to speculation. The easiest way to understand speculation is to think of it like a “bet” on the direction of a stock. Maybe a trader believes that a stock is a sure thing to go up. At the same time, they lack the funds to invest heavily due to the price of the stock. This trader can make money off of an options contract instead.
Sounds easy enough, right? The tricky part is determining not just the price of the stock, but also when the price is going to change. This complexity is part of what has given options signals a reputation for being risky.
High Risk, High Reward
Options signals have plenty of advantages. The ability to make money off of expensive stocks with less money upfront is one of the main ones. However, they do possess their own fair share of risk.
As we previously mentioned, an options contract comes with an expiration date. This doesn’t just make options wasting assets. It also means that an investor could be exactly right about his stock prediction, and still lose money. How is this possible? The trader needs to be within the correct time frame, as well. Options contracts are often short term, only lasting a few months. The stock behavior needs to react correctly in more than one way in this brief period.
This shorter time frame might turn off more conservative investors. Many traders look to hold on to their investments long term. If you’re looking at a buy and hold strategy, options signals are probably not the best trading vehicle.
Keep in mind that traditionally, initial options investments require smaller amounts of capital then their stock counterparts. Looking at it this way, the risk could actually be smaller. However, as with other securities, there are no guarantees. It’s possible to lose the entire initial investment.
If you’re looking for proven options signals and trading strategies, you’ve come to the right place. Schedule a call with one of our investment strategists today.