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Trader Q&A: Why Trade Options?

Randy Frederick discusses the benefits of trading options.

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Even if you've never traded options, you might be surprised to learn that some of the more basic strategies can provide an effective way for investors to try to generate income or hedge against risk and sometimes both at the same time. While some options strategies can be complicated, the ones that makes sense for most investors are often relatively straightforward. Let's start with the basics.

With stocks, you're pretty limited to buying, selling and selling short. With options, the possibilities are virtually unlimited. The options market offer bullish and bearish strategies, hedging and speculative trading opportunities in varying degrees of potential for risk and profit. Option strategies maybe based on time, volatility or even interest rates.

Combining options with stocks and there are even more possibilities. Options can help you protect against risk, generate income, increase profits, lower your breakeven point, reverse your strategy without even selling the stock or even potentially let you set a purchase price for a stock below its current market price.

While options do provide a lot of flexibility and they can generally be bought and sold at any time in the market place. The owner of a long option has the right to exercise the option but is by no means obligated to do so.

This is a critical concept because with any option strategy used on dividend paying stocks, you won't be entitled to any dividends unless you purchase the actual stock before the ex-dividend date. With option strategies, you also won't be entitled to voting rights or any of the other benefits of stock ownership unless you actually own the stock.

Now, virtually all option strategies involve some sort of trade off. They allow you to increase your probability of success under certain outcomes but you'll need to be willing to give up something else in return.

Finally, since all options eventually expire, they will generally lose value as their expiration date approaches and may end up completely worthless, whereas as a stock position can often be held for a very long period of time.

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