The world of investing and distributing highly valued money is anything but simple. People will go in every direction to increase their earnings. The phrase “money makes money” is widely recognized because, despite being a cliché, it’s true. With more money in investments, the risk vs. reward is significantly higher. So, what if we could simulate a huge amount of shares in companies that increase our risk vs. reward for potentially massive returns, without having to pour in the amount of money it takes to get there? Investors use both call and put options because they offer different ways to act on research and market expectations. A call option gives an investor the right to buy a stock at a predetermined price, while a put option gives the investor the right to sell it at a predetermined price. For someone who has spent significant time researching a company, its financial statements, industry, competitors, and market conditions, options can provide a way to turn that research into a specific investment strategy. Rather than simply buying a stock and hoping it rises, an investor can choose an option that reflects how strongly they believe the stock will move, the direction they expect it to move, and how long they expect the move to take.
One of the biggest reasons people use call options is leverage. If an investor believes a stock will rise substantially, buying 100 shares requires paying the full market value. A call option, however, allows the investor to pay a smaller premium for the right to purchase those shares at a predetermined price. If the stock rises significantly, the option can increase substantially in value. This makes calls attractive to investors with a strong bullish view because they can potentially earn a larger percentage return on a smaller initial investment. The only tradeoff is that the option has an expiration date, so the investor’s prediction must be correct not only about the stock’s direction but also about the timing. Put options serve a similar purpose, but in the opposite direction. It is similar to shorting a stock, where the investor believes the company will decrease in value or go bankrupt. If an investor researches a company and believes its stock is significantly overvalued or likely to fall for a variety of reasons, buying a put can let them benefit from that decline. This is useful because simply owning a stock does not provide a way to profit from falling prices. Puts give investors a way to express a declining view without having to sell a stock they already own or take on the risks of directly shorting shares.
People also use both calls and puts when they have a strong opinion that something will happen but don’t know how the market will react. For example, an investor might believe that an upcoming earnings announcement, product launch, or report will cause a stock to move dramatically. Although they may be uncertain whether the stock will rise or fall, they are confident that it will move in some direction. Certain options strategies allow investors to structure positions around that expected volatility. In different situations, investors combine options with stocks they already own to hedge against losses. They are not only instruments for speculation, but they can also be tools for mitigating risk. Investors use calls and puts because they let them be more specific in their investment analysis. Someone who has done extensive research might not think “I believe this company will do well.” Instead, they will think, based on my research and everything I know, “I believe this company will outperform expectations within the next six months.” Calls can portray a bullish thesis; puts portray a bearish thesis, each within a specific time frame. Combining the two supports more complex investing strategies.
However, having a well-researched opinion does not remove the risk involved with options. An investor can correctly predict that a stock will eventually rise and still lose money on a call if it doesn’t rise quickly enough before expiration, even if it still rises. The same problem applies to puts. Options also lose value as expiration approaches, and investors risk losing the entire premium they paid. Experienced investors use both calls and puts not because they want to take bigger risks. It is because options allow them to translate a specific view into an investment position. When an investor’s research is strong, that flexibility can be valuable, but the leverage and expiration dates mean that being right about the general market does not necessarily mean being right about the option.
Enter at your own risk.
