4 Advantages of Options (2024)

Options trading has become very popular in recent years thanks to low-cost electronic trading, improved pricing models, and online analysis tools. They offer unique advantages like portfolio protection and additional income when used judiciously. This article explores how options work and the four major advantages they have for individual investors.

Key Takeaways

  • Options are derivatives contracts that give the buyer the right, but not the obligation, to either buy or sell a fixed amount of an underlying asset at a set price on or before the contract expires.
  • Used as a hedging device, options contracts can reduce risk for investors.
  • For speculators, options can offer lower-cost ways to go long or short the market with limited downside risk.
  • Options also give traders and investors more flexible and complex strategies, such as spread and combinations, that can be potentially profitable under any market scenario.

Once considered complex and risky investments only suitable for expert traders, listed options have become increasingly accessible to ordinary investors. Even after options started trading on exchanges like the Chicago Board of Options Exchange in 1973, they were for decades still viewed as too complicated, opaque, and costly for the average investor to understand and utilize effectively. However, all that has changed. According to the Options Clearing Corporation, the central clearinghouse for all listed options on U.S. exchanges, about a quarter billion options were traded in 1993. Jump ahead 20 years, and there were 4.2 billion options traded in 2013. Five years later, there had been an increase of about 24%, to 5.2 billion. By 2023, the number of options traded was about 10.2 billion, just about doubling through and past the pandemic period. The four advantages below offer some reasons why this has been the case.

Advantages of Options

Though they have been around for centuries, options are only now gaining the wider attention they deserve. Many investors have avoided them, thinking they are too difficult to understand. Many more have had bad initial experiences with options because neither they nor their brokers were properly trained to use them. Like any tool, improper use of options can lead to major problems.

Words like "risky" or "dangerous" have also been incorrectly attached to options by the financial media and certain popular figures in the market. However, we can quickly demystify options here, and you can see if the options are viable and strategic vehicles for reaching your investment goals.

Options trading offers diverse strategies to suit almost every market scenario. Traders can optimize their positions by buying or selling calls (the right to buy) and puts (the right to sell), aligning with their market expectations, whether bullish or bearish. Individual investors should develop subtle strategies, often involving combinations of several puts and calls. For instance, traders might buy call options when the market shows upward momentum and the buying volume is moderate. Conversely, they might buy put options during market downturns when buying volume is subdued, benefiting from the increase in value as the market declines. Besides these strategies, traders frequently blend long and short options. These can be useful for capping potential losses, as they define the maximum risk involved.

While this can appear complicated quickly, the point is that investors can use options for insurance, leverage, and more, which is why they've grown in popularity. Here are four key advantages options offer:

  • They can provide increased cost-efficiency.
  • They can be less risky than equities.
  • They can, at times, deliver higher percentage returns.
  • They can offer investors strategic alternatives.

Let's look into these advantages one by one.

1. Cost-Efficiency

Options have great leveraging power. As such, an investor can obtain an option positionmuch likea stock position but at a huge cost savings. For example, to purchase 200 shares of an $80 stock, you would have to pay $16,000 (leaving fees aside). However, if you purchase two $20 calls (with each contract representing 100 shares), the total outlay would be only $4,000 (two contracts times 100 shares per contract, then times the $20 market price). You would then have $12,000 left to use at your discretion.

Obviously, it is not quite as simple as that. The investor has to pick the right call to purchaseto mimic the stock position properly. However, this strategy, known as stock replacement, is not just viable but also practical and cost-efficient.


Suppose you wish to purchase the stock of XYZ Corp. because you think it will go up in the next few months. You want to buy 200 shares while XYZ is trading at $131; this would cost you $26,200. Instead of putting up that much money, you could have gone into the options market, picked the option mimicking the stock closely, and bought the August call option, with a strike price of $100, for $34.

You would need to buy two contracts to acquire a position equivalent in size to the 200 shares mentioned above. This would bring your total investment to $6,800 (2 contracts x 100 shares/contract x $34 market price) instead of $26,200. The difference could be left in your account to gain interest or be applied to another opportunity providing better diversification, among other possibilities.

2. Reduced Risk (If Used Properly)

Options are a dependable form of hedge, and this can make them safer than stocks. When an investor purchases stocks, a stop-loss order is frequently placed to protect the position. The stop order is designed to stoplosses below a predetermined price identified by the investor. The problem with these orders lies in the order itself. A stop order is executed when the stock trades at or below the limit as indicated in the order. However, when there's high market volatility or gap openings (when the stock price opens significantly higher or lower than the previous close), stop orders may be triggered. The stock may trade past the stop price, leading to larger-than-expected losses.

By contrast, options provide more control. Buying a put option, for instance, you can set a definitive floor for potential losses, as the investor has the right, but not the obligation, to sell the stock at a predetermined strike price, no matter how low the market price of the stock drops.


For example, you buy ABC, Inc. stock at $50. You do not wish to lose over 10% of your investment, so you place a $45 stop order. This will become a market order to sell once the stock trades at or below $45. This order works during the day but may lead to problems at night. Say you go to bed with the stock having closed at $51. The following day, when you wake up, your phone buzzes with breaking news on your stock. The company's CEO has been lying about the earnings reports for quite some time now, and there are rumors of embezzlement. The stock is expected to open down around $20. When that happens, $20 will be the first trade below your stop order's $45 limit price. So, when the stock opens, you sell at $20, locking in a considerable loss. The stop-loss order was not there for you when you needed it most.

You might not have suffered the catastrophic loss if you purchased a put option for protection. Unlike stop-loss orders, options do not shut down when the market closes. They give you insurance 24 hours a day, seven days a week. This is why options are considered a dependable form of hedging.

Also, as an alternative to purchasing the stock, you could do a stock replacement, where you purchase an in-the-money call instead of purchasing the stock. Someoptions mimic up to 85% of a stock's performance but cost one-quarter of the price of the stock. If you had purchased the $45 strike call instead of the stock, your loss would be limited to what you spent on the option. If you paid $6 for the option, you would have lost only$6, not the $31 you'd lose if you owned the stock.

3. Higher Potential Returns

You don't need a calculator to determineif you spendless money and make almost the same profit, you'll have a higher percentage return. When they pay off, that's what options typically offer to investors. Let's look again at their leverage effect. When you buy an option, you're paying for the right, but not the obligation, to buy or sell an asset at a specific price within a certain time frame. This allows you to control a larger amount of the underlying asset with a relatively small investment, the option price. For instance, if a stock goes up in price significantly, the value of a call option can increase several times over, resulting in a substantial return relative to the initial cost of the option.


Using the scenario above, let'scompare the percentage returns of the stock (purchased for $50) and the option (purchased for $6). Let's saythe option has a delta of 80, meaning the option's price will change 80% of the stock's price change. If the stock goes up to $5, your stock position would provide a 10% return. Your option position would gain 80% of the stock movement (because of its 80 delta), or $4. A $4 gain on a $6 investment amounts to a 67% return—much better than the 10% return on the stock. Of course, when the trade doesn't go your way, options can exact a heavy toll: you can lose 100% of your investment.

4. More Strategic Alternatives

The final major advantage of options is they offer more investment alternatives. Options are a very flexible tool. There are many ways to use options to recreate other positions. We call these positions synthetics.

Synthetic positions give investors many ways to attain the same investment goals, whichcan be very useful. While synthetic positions are considered an advanced topic,options offer many other strategic alternatives. For example, many investors use brokers whocharge a margin when an investor wants to short a stock. The cost of this margin requirement can be prohibitive. Other investors use brokers whosimply do not allow for the shorting of stocks, period. The inability to play the downside when needed virtually handcuffs investors and forces them into a black-and-white world while the market trades in color. But no broker has any rule against investors buying puts to play the downside, and this is a definite benefit of options trading.

Options allow the investor to trade not only stock moves but also the passage of time and changes in volatility. Most stocks don’t have large moves most of the time. Only a few stocks actually move significantly, andthey do it rarely. Your ability to take advantage of stagnation could be the factor deciding whether your financial goals are reached or remain simply a pipe dream.

Options strategies can be tailored for different market conditions and risk appetites. Strategies like buying calls in anticipation of a stock’s rise or buying puts when expecting a stock’s fall can lead to significant profits if the market moves as you expected. Advanced options strategies like spreads, straddles, and strangles can be employed to capitalize on high or low market volatility.

How To Start Trading Options With My Broker

Getting started with trading options through your online broker is pretty straightforward. Here are the key steps:

  1. Make sure your brokerage account allows options trading privileges. Some brokers require you to apply for options approval based on your experience level specifically.
  2. If required, request options approval for your account. You may need to submit some background information or take a short quiz about options risks. You may also need to simultaneously apply and be approved for margin trading on your account.
  3. Review available educational resources from your broker or elsewhere on options trading fundamentals or consider virtual trading platforms to practice first if brand new to options.
  4. Fund your account with enough cash to purchase options contracts and cover any future obligations they may create. Be aware of margin requirements, too.
  5. Use your broker’s options chain search tools to find and analyze options contracts to potentially buy or sell based on your chosen strategy and expectations.
  6. Place opening orders to purchase contract options you want to buy or sell/write contracts to open short positions at your preferred strikes and expirations. Be aware that fees and commissions may apply.
  7. Monitor your options trades closely and understand tax implications for later. Adjust or close positions before expirations based on your trading plan.

Which Options Strategies Are Best-Suited for Beginners?

Basic options strategies like buying puts or calls can offer a straightforward way to bet on market moves or hedge. Using covered calls (holding assets and selling upside call options on them) can be a low-risk way to generate income. Spread strategies that combine both puts and calls can mitigate risks for new options traders with limited downside.

What Are the Main Risks of Options Trading?

Options buyers can lose 100% of the premium paid for options that expire worthless. So, the main downside risk is the upfront payment, while potential profits will often offer a higher upside potential. Options expire per their contractual dates, so new traders sometimes fail to pay attention to expiry dates. This can eliminate any remaining time value/leverage when you want it.

Options also have more moving parts and complexity than simply owning stocks. This can lead to unintended risks or losses if newer traders misuse more advanced strategies or don't fully understand option pricing. Some options strategies, like writing uncovered calls, have theoretically unlimited risk if the market moves strongly against you. This can quickly result in losses much bigger than your capital if proper risk management isn't used.

Why Do Most People Fail At Options Trading?

Most people fail at options trading because they have not taken the time to learn how options work and how volatility affects options pricing. People often lack sufficient knowledge about how to use options properly and may not have prepared a trading plan which includes understanding and preparing for trading risk when using options.

The Bottom Line

With online brokerages providing direct access to the options marketsand very low commission costs, the retail investor now has the ability to use a very powerful tool to mitigate risk and leverage gains. Their benefits include cost efficiency, lower risk, higher potential returns, and providing strategic alternatives.

4 Advantages of Options (2024)


What are the 4 options strategies? ›

Here we look at four such strategies: long calls, long puts, covered calls, protective puts, and straddles. Options trading can be complex, so be sure to understand the risks and rewards involved before diving in.

What is option advantages? ›

For speculators, options can offer lower-cost ways to go long or short the market with limited downside risk. Options also give traders and investors more flexible and complex strategies, such as spread and combinations, that can be potentially profitable under any market scenario.

What are the advantages of call options? ›

Advantages of In the Money Call Options

Once a call option goes into the money, it is possible to exercise the option to buy a security for less than the current market price. That makes it possible to make money off the option regardless of current options market conditions, which can be crucial.

Which of the following are the advantages of option? ›

Advantages of options trading
  • Cost-efficiency: Options have great leveraging power, allowing investors to obtain an option position similar to a stock position, but at significant cost savings. ...
  • Risk reduction: Options contracts can provide investors with risk-reduction strategies. ...
  • Higher percentage returns: ...
  • Flexibility:

What are the 5 strategic options? ›

Strategic Options Assessment: Five Strategies for Success
  • Conduct an operations assessment. ...
  • Assess market factors. ...
  • Determine structural goals. ...
  • Dual track transaction process considerations. ...
  • Define exit path.
7 days ago

What is the 4 leg strategy? ›

Four-Leg Strategy: Iron Condor

Profits are capped at the net credit the investor receives after buying and selling the contracts, but the maximum loss is also limited. Building this strategy requires four legs or steps. You buy a put, sell a put, buy a call and sell a call at the relative strike prices shown below.

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