Are you thinking about trading options? Does it make sense for your short- and long-term goals? Options have unique characteristics and risks, and should be carefully considered within the context of your overall investing plan. If you are managing your own investments, here's how you can help decide if options are right for you.
Who are options suitable for?
The decision whether it makes sense for your investing plan to include options boils down to what your goals are and how much risk you are comfortable taking. Let's consider a few hypothetical scenarios that might help shed some light on your specific situation.
Investors who are looking to trade the market. If there is a group of individual investors who might consider trading options, it is most likely active investors who are looking to make tactical trades (e.g., taking a long or short position, targeting an expected level of volatility, etc.) with some percentage of their investing funds. Of course, these types of investors still need to understand the risks and characteristics of options, could benefit from having experience with tactical trading strategies, and should be able to actively monitor the market and their trading position.
Investors who are looking to generate income. A common goal for many investors is to generate current income. Suppose you own a portfolio that includes mutual funds, ETFs, stocks, bonds, and other investments, and further suppose that you are looking to generate additional income. There are options strategies, such as the covered call, that can supplement these holdings and might be something to consider. Of course, it's important to understand the risks and how these types of strategies work.
Who might not want to consider trading options?
Buy and hold investors. Individual investors whose investing plan involves buying stocks, bonds, and other investments with a multiyear time horizon may not typically consider trading options (although there can be circumstances where it may be appropriate). Stocks, for example, are commonly held by many investors for years, and can be owned indefinitely. Alternatively, options have a defined expiration date and are typically shorter-term positions. Investors that want to use most or all of their investment funds for the long term, and would prefer not to actively manage their investments, might not usually choose options.
Inexperienced investors. Options are more complex investments than stocks. Whereas owning stocks gives you partial ownership of a company, options grant the right (but not the obligation) to buy or sell the underlying stock. This is just one example of added layers of complexity. Of course, it is possible to mitigate this obstacle by learning about the different aspects of options. So newer investors that do not have the experience or knowledge of how options work, and the risks involved, may want to first learn about options before considering them.
Of course, each investors' situation is unique. You need to make your own determination if options make sense for you. There are a variety of reasons why you might be interested in trading options. Regardless, every investment plan should include an assessment of your individual goals, risk constraints, time horizon, tax constraints, and liquidity needs. Options have unique characteristics and risks, and should be carefully considered within the context of your overall investing plan.