3 Reasons To Buy Options
By: Marc Guberti
Tags: Options Trading, Investing, Stock Market, Work, Money

3 Reasons To Buy Options

Options trading is commonly depicted as an investment not worth the risk. It’s true that some people lose a lot of money with options, but the same can be said about any investing opportunity as a whole.

Plenty of options traders have achieved astronomical returns you don’t typically see in the stock market. While these options traders tend to lean more on the speculative side, there are a few practical reasons for any investor to trade options.

#1: Lock In The Price

Let’s say you are bullish on a stock and want to build up a sizable position. However, there’s one catch…you don’t have enough money to buy a sizable position.

You could buy a few shares with your current cash position, but for some investments, it’s better to buy an option and lock in a price.

Magnite is one of the stocks that has been on my radar. At one point, I only had a few hundred dollars that I could invest into Magnite stock.

Rather than buying shares, I bought a Magnite call for $240.69 which allows me to buy 100 shares of Magnite stock at $15 apiece on March 19, 2021.

I bought this contract in mid-November when Magnite stock was trading at around $14.50 per share. I could have bought roughly 16 MGNI shares rather than buy the option.

However, the option proved to be the better investment because I locked in the price for 100 shares. Magnite stock is currently priced at $32.50 and has enormous upside.

Rather than having an extra 16 share at $14.50/share ($288 gain looking at the current price), I’ll have an extra 100 shares at a cost basis of $17.41/share ($1,509 gain looking at the current price).

I have plenty of time to allocate $1,500 for the 100 Magnite stocks because the option expires in the middle of March. You can buy an option with an expiration date that falls in line with a raise or a busier time for your business to ensure you have the proceeds to exercise the option.

If you don’t have the necessary proceeds, you can exercise the option for profits. The option I paid $240.69 for can currently be sold at roughly $1,760 although I plan to exercise this option.

#2: Leverage Without Margin

Investing with margin is incredibly risky as you take on debt hoping your investments will go up.

Any gain or loss in your portfolio gets doubled. This is tremendous news during good times but devastating news during bad times. For several investors, this risk is far too great to weigh the rewards.

Options trading eliminates this risk. The only risk you have with options trading is losing your entire investment. The $240.69 I put into the Magnite stock option could have turned into $0.

You can mitigate this risk by making options a small percentage of your portfolio. When you’re starting out, make options less than 1% of your portfolio.

Options are currently a little over 2% of my portfolio, and that’s based on their appreciation rather than the initial investment. These are long-term options that expire at least a month later rather than the following week.

Putting all of your money into options creates a similar risk scenario as margin (minus accumulating debt) and is not recommended. But putting 1% of your portfolio into options can present the potential gains of a margin account with a barely noticeable downside if the options don’t work out (i.e. since the stock market can move up or down 1% on any given day, losing 1% of your portfolio is barely noticeable).

#3: Protect Yourself From Downside

Not only can you use options to benefit from stock appreciation, but you can also use options to protect yourself from downside.

Some investors get concerned that good companies they’re invested in have become overvalued. They get worried about a potentially bad earnings report, negative news, or some other malefactor.

In the past, I would panic and sell my shares. Sometimes I’d buy back into the stock later on while at other times I wouldn’t. This resulted in over $40K in missed gains from Shopify’s rally which I talked about in this article.

Then I got into options trading. I faced a similar test with Fastly stock as it rose above $120 per share. Fastly stock was starting to give way, and rather than selling, I bought a short-term put option on the stock.

Puts reward you when a stock goes down in value as they allow you to sell 100 shares at a set strike price.

Having this put in place gave me an extra layer of security. I knew that I was protected from downside and was more confident with holding onto my shares.

It was at around this time when Fastly lowered their revenue guidance going into earnings and TikTok was starting to look like it was in jeopardy. The stock fell over 25% in one day and the put I had in place protected me from those losses.

Rather than exercise the put, I sold the put and still have my Fastly shares today. If I was trading options earlier, I’d probably have more Shopify shares because I’d buy a put when I felt nervous rather than sell my entire position and then try to re-enter at a better time (a big no-no in investing).

These options trading strategies can be readily applied by any investor. You can get speculative with options but this is a more sound approach to utilizing a powerful investment vehicle that can help you crush the market without taking on excessive risk.

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