Options may be effective at reducing risk in your
investment portfolio, since they can act as insurance policies
against a drop in stock prices or produce income through strategies
that limit the maximum loss to which you're exposed.
Options
can be used to hedge,
or protect against losses in another investment. For example,
you might hedge against a drop in the price of a stock you own
by purchasing a put on that stock. In return for the premium you
pay, you'll have the right to sell the shares at a price
that's acceptable to you, locking in unrealized profits
or preventing losses below the strike price. In that case, your
option works like an insurance policy, protecting you against
loss.
Risking
less
Buying options always carries limited risk, since
your loss is limited to the price you pay for the
premium. The amount of that
premium
is generally much smaller than holding the equivalent
shares of stock, so the capital that's at risk
in your options position is usually relatively small
compared to other investments.
Options
can be used to 