Question

Options are a very flexible security to add to an investment portfolio. They can be added to increase portfolio yields, protect investment positions, or take advantage of movements within sectors of the economy or movements in the economy as a whole. For this discussion: Describe the various options available to investors and how they can be used to accomplish the goals above.

Answer 1

There are numerous number of options which are available in the market which can be categorized in a number of ways but the most important and popular categories of options are put options and call options.

1. Call Options : "Call" here refers to the "long/buy position", i.e., it gives the option holder an option to buy the securities at the mentioned exercise price. This option can be purchased by paying an option premium. With this option the holder can be in any of the following 3 conditions :

a. In the Money (Share price > Exercise price)

b. Out of the money (Share price < Exercise price)

c. At the money (Share price = Exercise price)

2. Put Options : "Put" here refers to the "short/sell position", i.e., it gives the option holder an option to sell the securities at the mentioned exercise price. This option can be purchased by paying an option premium. With this option the holder can be in any of the following 3 conditions :

a. In the Money (Share price < Exercise price)

b. Out of the money (Share price > Exercise price)

c. At the money (Share price = Exercise price)

Some other options available to the investor are as follows :

3. European style option : In this option you can only exercise your right to sell or buy the shares on the expiration date.

4. American style option : In this option you can exercise your right to sell or buy the shares at any time before the expiry date.

5. Employee Stock Options : Here, the company provides ESOPs to the employees which gives them a right to buy the share after providing services for the vesting period after which they can purchase the shares during the exercise period.

Options has numerous advantages which are very beneficial for the investors. Due to following advantages investors should include options in their portfolios :

1. Less investment required/Cost effective investment : In order to obtain an option, you only have to pay the option premium which is marginally less than the original price of the shares. Hence if you do not have enough to purchase the regular stocks, you can always play your luck by purchasing the options.

2. Higher Returns : Since you are spending less, obviously, your returns would be much much higher.

3. Limited loss and risk : Options are not required to be manadatorily exercised. It is the decision of the holder as to whether to exercise the options or not. Hence ideally the holder will never exercise the options if he is at a loss which means that the maximum possible loss for the holder is the option premium he paid for purchasing the options which reduces the risk and loss.

4. Provides more alternatives : There are numerous strategies existing currently in the market such as butterfly spread, strip and strap strategy etc. in the options market. Options provide you with various alternative strategic options and not just purchasing a share and waiting for the value to rise. Investors can diversify their portfolio in various ways.