For many investors, a simple mix of stocks, bonds, ETFs, and mutual funds provides a solid strategy to meet their financial goals. But as the past several years have shown, investing is a dangerous business, and to have the greatest chance of success, you need to have as many strategies in your investment toolbox as you can.
One often-neglected investment method is options investing. Many investors see options as a highly risky, short-term-oriented practice that's more likely to cause them to lose their shirt than to improve their results. But the right options strategies not only avoid huge risks but actually reduce the volatility of your overall portfolio, giving you the safety and security you want in tough financial times like these.
Giving you more options
That's why The Motley Fool has called on several of its contributors to share their option strategies with you. We firmly believe that options give investors opportunities that they couldn't take advantage of with other strategies.
Over the next several weeks, you'll get details on some interesting ways to use options to help you make money and protect your portfolio. But in this article, I want to focus on a simple question: Why are options worth looking into at all?
The nuts and bolts of options
Options have two key characteristics that make them attractive for many investors. One is that options let you do more investing with less money. For instance, some stocks cost hundreds of dollars for a single share. But with the same amount of money, you can buy options controlling hundreds of shares.
That in turn can lead to huge profits from short-term moves. Consider these recent situations:
- When Google (Nasdaq: GOOG ) announced its bid to buy out Motorola Mobility (NYSE: MMI ) last month, Motorola shares jumped more than 50% in a single day. But some option holders saw gains of 2,000% or more.
- Similarly, speculation that Clearwire (Nasdaq: CLWR ) might get a takeover bid from Sprint (NYSE: S ) and Comcast (Nasdaq: CMCSA ) pushed shares up more than 30% on Aug. 19.
On the other hand, options let you benefit from downward moves as well. When mobile phone software provider Motricity (Nasdaq: MOTR ) and content-delivery facilitator Limelight Networks (Nasdaq: LLNW ) plunged recently, those who held bearish put options saw big returns.
The other side of the coin
From all that, you might conclude options are only for home run hitters. But the other attractive characteristic of options can help any investor: the fact that options let you tailor your risk tolerance.
For instance, the same options that other investors buy in the hopes of huge gains can give you the chance to earn extra income on stocks you already own. By taking the other side of an options trade with someone who hopes that a stock will crash, you can get both current income and the possibility of buying an attractive long-term investment at a bargain price.
Moreover, options let you decide exactly how much money you want to put at risk. Critics of options point out that many people who buy options lose the full amount of their investment. But the flip side of that argument is that you can decide which option you want to buy -- and therefore how much you're willing to lose. With a plain investment in stocks or ETFs, the price you see is what you pay; and as a result, you might lose far more of your money than you'd prefer.
Keep your options open
Whether you like the idea of a strategy that lets you call all the shots or you're skeptical that options are just another Wall Street gimmick to grab your hard-earned money, continue checking into our Options series over the next several weeks. We'll show you everything you need to know about options -- and then leave it to you to decide whether they have a role to play in your portfolio.
To learn more:
- 3 Simple Options Trades on Companies You Already Know
- How to Strangle Profits From an Uncertain Market
- How a LEAP of Faith Could Aid Your Portfolio
- Use This Trick to Double Your Dividends
- 2 Ways to Profit From a Crazy Market
- Save Yourself From America's Downfall
- The Safer Strategy to Bet on a Bounce
- The 2 Secrets of Investing Success
- Build a Great Portfolio Without Breaking the Bank
- Turn These Dividend Chumps Into Cash Cows
- The Best Stocks to Profit From Options
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.