Investing can be deeply personal. Each individual has their own risk tolerance, strategy, goals, and preferences that play into how they form their portfolio.
This means that not every asset may be right for every person. And that’s certainly true with options. While options can be a great resource for the right type of investor, this asset won’t fit into everyone’s strategy. In fact, not all investors qualify to trade options.
So should you trade options? Let’s take a look at two potential metrics you might consider to make that decision.
Your anticipated activity
If you’ve ever felt like stock investing could use a little more hands-on action, options trading might be for you.
Options, at least in their basic form, require you to have some kind of opinion about the market. If you’re a finance news junkie, options are a great place to apply that knowledge in a hands-on way. For example, if you know your favorite company’s earnings are coming up, you could use your knowledge on the company to trade an option.
Think the stock will go up after the earnings report? Consider buying a call. Think it’ll go down? Consider buying a put. And of course, this doesn’t just apply to earnings — this could apply to any big event that you see on the horizon.
Common wisdom about the stock market says that if you wait long enough, the market (as a whole) will go up. This means that many people simply set and forget their investments until they have a big life event, like retirement, when they want to take it out.
Options aren’t like that — they’re very dependent on market movements and have expiration dates, and therefore are more suited to those who like to keep a close eye on their investments and the companies that they are related to.
Maybe you’re an intermediate investor who loves doing research, or a short-term investor who loves flipping stock. For these kinds of personalities, options might be a natural next step into the wider world of investing.
Your risk tolerance
You might think that we’re going to say only those with a high risk tolerance should trade options. And while on some level, that’s true (you won’t qualify to trade options if your risk tolerance is too low), there are ways that more cautious investors could use options to help hedge against risk.
But first, let’s talk about the high-risk investors. Options have a reputation for being high risk, high reward. If you love chasing that high of making a really good investment that could make you a lot of money, quickly, options might be a vehicle to explore.
With any options investment, there’s a relatively high probability that you could lose your entire investment — your premium* (and in rare cases, more than that). But the great part about this is that your premium will be much less than the cost of the 100 shares that the option is derived from. So, rather than spending $1,000 on 100 shares, you might be spending (and therefore potentially losing) $100 total on a call option.
On the flip side, if your investment goes the way you planned, you could make a substantial profit, since you only spent $100 in the first place. (For more on how this works, check out this article.)
For the more conservative investor, you might want to use options to hedge against risk. For example, if you buy a large amount of stock in a company, it might be worth it to invest in a put. That way, if your investment ends up going down, rather than up, you still have a chance at making some money. (You can learn more about that here, in the “Options as a hedge” section.)
As you can see, your risk tolerance definitely plays into how you might trade options. But there are so many types of options, that as long as you have a little bit of risk tolerance, there are places to work them into your portfolio.
Your decision
At the end of the day, you need to do some self-exploration to see if options are the right fit for your portfolio. They’re another way to diversify, an interesting way to hedge, or a hands-on approach to investing, depending on how you use them. But most importantly, they’re just one tool in your toolbox — one that you need to decide if you want to use.
To start exploring options, download the eToro app.
*There are certain edge cases in which you may be exposed to greater loss than your initial investment. Although these instances are rare, they can occur.
Options involve risk and are not suitable for all investors. Please review Characteristics and Risks of Standardized Options prior to engaging in options trading.