Can Options Help you Control Risk?

Options can be a great way to get leverage in the stock market.  In some ways they can even be used to help manage risk in the stock market.

If you get into a stock that is trading at $50 and expect it to go up, it can be pretty risky.  Say you buy the stock and some bad news comes out of nowhere, which affects the stock. Sure you can always put a stop on your position.

But if the stock gaps down and opens at $40 a stop at $47 isn’t going to help you much, you’ll still get filled way below what you where assuming was your max risk was.

If, instead of buying the stock at $50 you bought the $50 call for $4.  This way you know that $4 is the absolute most you can lose on this trade.  If the company you are trading declares bankruptcy tomorrow (as unlikely as it is) the most you could lose is $4.

This way you are not guessing your max loss, you already know.

In this way buying options is a great way for you to control the same amount of shares as you would if you bought the stock, but have less risk, especially if the stock you are buying likes to gap.

Of course options have risk too.  You are way more likely to lose 100% of your investment when you trade options then you would if you where trading stocks.  You cannot simply buy an option contract cross your fingers and hope everything turns out alright.  Because of this they force you to be much more cautious with your account.  

Being Cautious is always a good thing, if you take your account down to $0 by holding that stock that “had to come back” is not fun. 

Of course stock options aren’t for everyone, but they can help you to control your risk.

For more on stock options visit http://www.stocks-simplified.com/stock_options.html