The stop order is designed to stop losses below a predetermined price identified by the investor.
Options Margin Requirements
The problem with these orders lies in the nature of the order itself. A stop order is executed when the stock trades at or below the limit as indicated in the order. For example, let's say you buy ABC, Inc. This order works during the day, but it may lead to problems at night. The next morning, when you wake up and turn on CNBC, you hear that there is breaking news on your stock. It seems the company's CEO has been lying about the earnings reports for quite some time now, and there are also rumors of embezzlement.
The stop-loss order was not there for you when you needed it most.
Had you purchased a put option for protection, you would not have suffered the catastrophic loss. Unlike stop-loss orders, options do not shut down when the market closes. They give you insurance 24 hours a day, seven days a week. This is something stop orders can't do. This is why options are considered a dependable form of hedging. Furthermore, as an alternative to purchasing the stock, you could have employed the strategy mentioned above stock replacement , where you purchase an in-the-money call instead of purchasing the stock.
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The effectiveness of stop orders pales in comparison to the natural, full-time stop offered by options. You don't need a calculator to figure out if you spend less money and make almost the same profit, you'll have a higher percentage return. When they pay off, that's what options typically offer to investors. The final major advantage of options is they offer more investment alternatives.
Options are a very flexible tool. There are many ways to use options to recreate other positions. We call these positions synthetics. Synthetic positions present investors with multiple ways to attain the same investment goals, which can be very useful. While synthetic positions are considered an advanced option topic, options offer many other strategic alternatives. For example, many investors use brokers who charge a margin when an investor wants to short a stock.
The cost of this margin requirement can be quite prohibitive.
Call Credit Spreads
Other investors use brokers who simply do not allow for the shorting of stocks, period. The inability to play the downside when needed virtually handcuffs investors and forces them into a black-and-white world while the market trades in color. But no broker has any rule against investors purchasing puts to play the downside, and this is a definite benefit of options trading.
The use of options also allows the investor to trade the market's "third dimension," if you will—no direction. Options allow the investor to trade not only stock movements but also the passage of time and movements in volatility. Most stocks don't have large moves most of the time.
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Only a few stocks actually move significantly, and they do it rarely. Your ability to take advantage of stagnation could turn out to be the factor deciding whether your financial goals are reached or they remain simply a pipe dream. Only options offer the strategic alternatives necessary to profit in every type of market. Having reviewed the primary advantages of options, it's evident why they seem to be the center of attention in financial circles today.
With online brokerages providing direct access to the options markets and insanely low commission costs, the average retail investor now has the ability to use the most powerful tool in the investment industry just like the pros do. So, take the initiative and dedicate some time to learning how to use options properly. It is the dawn of a new era for individual investors. Don't get left behind!
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Higher Potential Returns. More Strategic Alternatives. The Bottom Line. Key Takeaways Options are derivatives contracts that give the buyer the right, but not the obligation, to either buy or sell a fixed amount of an underlying asset at a fixed price on or before the contract expires.
Three Simple Options Trading Strategies for Making Money in the Market
Used as a hedging device, options contracts can provide investors with risk-reduction strategies. Yes, there are options strategies that give you cash up-front. How do you get a credit to your account? That happens when you enter a multi-leg order that involves selling as well as buying options. In the case of a credit spread, you earn more from selling the options than you pay for buying the other options. So you get cash right away. This level varies from broker to broker. You should have no trouble getting approved for Level 1 options trading.
That will give you some experience with options that you can use when you apply for a higher level. And yes, experience does matter. Your broker will ask you about your experience with trading options. Answer honestly. Additionally, your broker will ask you about your objectives when it comes to trading options.
In this process, a good broker is crucial. That will help you achieve a higher level. Of course, your broker will also look at the overall value of your account. If you do everything suggested here and still only get approved for Level 2 options trading, take a look at your application and account to identify the red flags.
Maybe you just need more experience, more cash, or more margin. Keep growing your asset value and learning about options. Printable PDF. What does that mean? Table of Contents.