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Why Options are Safer than Stock!

By: David Chandler

We prefer to trade in options rather than stock.

But you have probably been told or read that options are risky. Even worse, that you can lose your shirt trading them!

Who can you trust?

Let's take a look at stock ownership. What can happen if you buy stock?

Stock can go up in value

Stock can go down value

The price can go sideways.

Clearly if the price goes up you make money. Just as clear, with the second scenario you lose money.

However if there is sideways movement you will not directly gain or lose money. You will however incur costs through brokerage fees directly and indirectly lose money through what is know as "opportunity cost."

Opportunity costs result due to your inability to invest in other opportunities hence the loss of the opportunity to make additional profit.

So if you purchase stock you can only make money if the stock price goes up.

Now some of you may be thinking, "But what about shorting?"

Again this is another possibility but is does involve some complicated strategies coupled with uncapped risk. Based on this it is not an approach we would recommend.

To explain - when shorting stock you are selling stock you actually don't own. Your plan here is to sell high and buy back low. The difference in price is what makes up your profit.

Do you see what the risk is?

The risk is the value of the stock going up; especially if it goes up a lot!

As you have sold the stock at a lower price you now have to buy it back at a higher price. And so your loss can be substantial.

So, to summarize, when you trade stock you can really only make money if the price increases.

There is another consideration when trading in stock which is the high cost of owning stock.

Consider buying 200 shares at $25 the cost would be $5000. Should you buy at on the margin it will still cost $2500.

This is large outlay and therefore a large risk; even more so if you take into account you have a 1 in 3 chance of the value increasing.

You also have to consider in the equation the fact that stocks don't trend in away you can guarantee a profitable return all that often. So you have to be able to pick the right time to invest.

We can conclude that successfully trading in stock is expensive and difficult to do.

But options provide a great alternative.

To start with you have less of an initial investment. You can invest about 2% of the stocks value but still have the control over the stock.

Based on the previous example your investment would be around $100 instead of $5000.

Add this to the fact if you get your game plan right you can profit no matter which way the stock price moves.

Last but not least, your risk is much lower. This is because the most you lose is the amount you invested.

But the best thing of all is the leverage that options provide.

In the above example, if the stock price goes up by $5, the profit on the stock trade would be 10% or on margin, 20%.

But with a similar increase in prices the value of your option may increase by 100%. This would give you a profit of 100% - this is ten times more profit than on the standard stock trade.

So by not accepting a commonly held view that the owning of stock is the least risky option you give yourself the chance of learning how to trade using options; opening up a good vehicle for your investments.

The above comments are offered for educational purposes only. We are not providing you with financial advice. We are simply sharing with you what has and hasn't worked for us personally. If you wish to trade or invest in the stock market you should obtain advice from a registered licensed advisor.

Article Source: http://www.articlesinsight.com

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