If you are a typical stock market investor, you adopted a buy and hold philosophy and own stocks or mutual funds. If you are a hand-on investor, you do research and carefully select stocks to own. It’s difficult to beat the market, and most professional money managers cannot do it.
Historically, stock market investing has worked out well. But that provides no comfort for those currently invested. The market recently traded at 12-year lows, and even more frightening is the idea that many investors lost half their assets over the past year.
Why did so many people watch their investments shrink in value and do nothing?
That’s a difficult question. Investors tend to be long. They own stocks. They don’t know how to hedge, or reduce the risk of owning, investments. That’s why options are so important. To me, it’s a crime that so few stockbrokers help clients to adopt risk-reducing strategies.
Here are 7 great reasons why you should take time to learn how options work:
- Hedging – Options allow you to reduce the risk of investing in the stock market. Imagine how investors everywhere would feel if they learned that the giant losses they suffered were unnecessary. By using appropriate strategies, those losses could have been trimmed by 50 to 90%.
- Insurance – You can buy insurance that protects the value of your portfolio – just as you buy insurance to protect the value of your home or car. This insurance is expensive, but there are strategies that allow you to own insurance for little, or no, cost.
- Income – By selling someone else the right to buy your stock at a predetermined price, you are paid a premium that you can consider to be a special dividend.
- Leverage – You never have to trade a share of stock, and invest far less money than stockholders.
- No Need to Always Be Bullish – Options allow you to create positions that prosper when the market moves higher, lower, or trades in a range. Traditional investors only prosper when stocks move higher.
- Limited risk – You can adopt strategies with limited loss, but with high probability of success. The trade off is that profits are also limited. The limited loss nature of so many option strategies is the single factor that makes them so attractive, in my opinion.
- Indexing – If you prefer to trade a diversified portfolio rather than individual stocks, the major indexes (e.g., S&P 500, DJIA, Russell 2000, etc) have options you can trade.