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Warren Buffet oftentimes makes use of stock options to abate risk in stock and to amass stock at a lowered cost. If he is using equity options, they must be lower exposure as compared with trading stocks alone. You can even trade equity options in your IRA. That is the candid reply, nevertheless keep on reading to find out what makes this true.
On a dollar for dollar position, option trading is less risky as compared with equity trading over a given epoch of time. For example, if you conclude Microsoft is going to advance in market value over the coming two months subsequent to break out of Vista, you can either procure the equity for near $29.50 per share or purchase a $30 strike price Jan '07 call for $0.70 per share. Considering a equity option covers one hundred shares, the option pay out is $70.00 to have control of one hundred shares versus $2950.00 to hold one hundred shares. If the stock goes up to $30.00 per share the option moves to approximately $092. You can figure out this using a stock option implied volatility calculator. That dinky flux in the stock results in a 30% gross profit on the equity option and a 1.7% gain on the stock. This is refered to as leverage and is a characteristic of stock options trading. By the third Friday in Jan '07, pretend Microsoft advances to $35.00 per share. Using your call, you can buy into the stock at $30.00 or you can just market your call for $5.00 per share, generating a 700% gain on the equity option.
What if Microsoft drops? If it drops back $5.00 to $24.50, you have lost $5.00 per share on the equity although the most you loose on call equity option is the amount you expended or $0.70 per share. That is hugely less exposure than owning stock if your forecast is in error and the equity goes down.
When going long or buying a stock option, your exposure is all the time fixed to how much you remitted and is at all times much less risk than owning the stock. The high exposure in equity option trading occurs when you short (sell) options and you do not have title to the equity for a call option you sell or have the hard cash for a put option you sell. There is plenty of money to be made without engaging in this type of trading.
Would it interest you to know that option trading can even cast aside the need to forecast whether a stock is about to move up or down? You can employ direction neutral equity option trading, such as strangle trading, to accomplish income if the stock moves either up or down. The risk in these trades is restrained to your beginning cost. At times it is possible to make some direction nonspecific equity option trades for a credit in your account.
Stock options can also be used to diminish your exposure in equity ownership. If you own a stock that is not moving, something that most stocks do almost 80% of the time, you can write a call option on the stock at a strike price above the stock cost your equity cost. For example, assume you paid $25 per share for equity and sell a $27.50 strike call option for $0.50 per share. If the equity goes to $27.50 when the option expires , you have to sell the stock at $2750. You would make a total of $3.00 per share ($2.50 on stock and $0.50 on option). If the stock declines or stays below $27.50 by expiration, you get to keep the equity and the premium you were paid when you sold the call option. That is something like generating your own $0.50 per share dividend. In addition it reduces your cost in the stock by $0.50 per share. Therefore the most you can give up on that stock is 24.50, not the original $2500.
So to answer the question, option trading performed correctly is eminently less exposure than stock trading. Stock options allow you to diversify a lot better with same measure of capital. The risk in stock options trading that is not present with stock trading is their limited lifetime. Stock options do expire. This means your forecast for the stock course has to transpire within the time context of the options you employ. This can range from 1 day to about 3 years.
Go online and inquire into option trading and the even lower exposure found in volatility trading.