You may be able to hedge some of the risks you
face as an investor, or limit the amount you spend to benefit
from market gains, by using options. An
option
gives you the right to buy or sell its underlying product at a
specific price, called the
strike price
or
exercise price, within a set timeframe.
In most cases, individual investors buy or sell options on stocks
and stock indexes. When you use options to limit your risk on
an individual stock, you're most likely to buy
put options
because you believe the price of the underlying
product — the stock or stock index — is going down.
In contrast, when you believe the market is going up, you might
buy
call options
on stocks you'd like to add to your portfolio.
When you sell call or put options, on the other hand, the premium
the buyer pays you can provide a source of income to enhance your
investment return. But if the options are exercised, and you must
follow through on your obligation to buy or sell, you risk losing
a substantial amount of money, or having to sell stocks you would
have preferred to hold.
Thomas J. Dorsey, President and
co-founder of Dorsey, Wright &
Associates
Study up
Trading options isn't suitable for all investors.
Before you buy or sell options for the first time,
you should download and read a copy of "Characteristics
and Risks of Standardized Options," from the
Options Clearing Corporation: www.optionsclearing.com
When you sell call or put options, on the other hand, the premium
the buyer pays you can provide a source of income to enhance your
investment return. But if the options are exercised, and you must
follow through on your obligation to buy or sell, you risk losing
a substantial amount of money, or having to sell stocks you would
have preferred to hold.
Thomas J. Dorsey, President and
co-founder of Dorsey, Wright &
Associates 