Like any other derivative, option trade has benefits and limitations. In most cases, the option itself is traded as a share stock. When the principal stock increases in value, the call option also increases its value. The contract is developed to speculate the price that the stock should have before the option is performed. This kind of price for calls is commonly known as strike price while that of puts is known as spot price.
The options derivatives have cost efficiency since they are embodied with a great leverage power. A trader in this derivatives have an option position that will impersonate the stock position almost similar, but have a great cost saving. For instance, when a person buys options, he/she is provided with more choices apply when building their investment strategy. This is irrespective of whether the stock that one is interested in increases or reduces in value. Therefore a trader can afford to be more flexible.
The other advantage of investing in option derivatives is that they exposes the trader to less risk depending on how they apply them. Sometimes, investing in options can expose an investor to a greater risk than owning equities. However, in some instance, the options can be used to reduce risks. They can have less risk because the investors need less financial requirements the equities (Baimbridge, Whyman & Burkitt 2011, pg.56). They can also be less risky because they have relative rigidity to potential disasters and uncertainties outcomes on gap openings.
Trading in options derivatives is also advantageous because they have more leverage. This is because the investors of options have capability to control huge shares of a stock with matching amount of money by purchasing options as an alternative of the stock itself. Consequently, the investors are able to gain more benefits from change in fortunes of a particular firm less amount of money than that they could have used to purchase stock in that specific company.
Another significant advantage of engaging in the option trade is that they offer more strategic alternatives in investment. This is because they are regarded as more flexible tools of investment since they provide many options to reconstruct other positions. These positions are commonly referred to as synthetic positions which provide the investors with numerous ways to achieve the similar investment goals (Baimbridge, Whyman & Burkitt 2011, pg.50).
Therefore, with regard to the discussed benefits of options, one is able to note that the options derivatives are becoming the hub of attention in the financial market today. However, the investment in options derivatives is not always beneficial as many claim to be
The investment in the options involves risky strategies. In some cases, the option trade as compensation it fails to benefit the interests of executives of shareholders as well as a company they have shares. The investment takes the risky strategies by increasing the value of the stock options.
The option derivatives also bring about the confusion of the investors. The stock options are not only purchased by the company employees only, but also by the other investors in the derivative market. As a result, they place a drawback whereby they can be confusing to the investors that have no experience in the market (Pannell & Schilizzi 2006, pg. 155). Terms, such as call, exercise price and put, are used in the stock market and exposes the inexperienced investors to confusion. Those that have no experience in the market may end up in losing a substantial amount of money in this investment.
The options derivatives have a lower performance compared to the other investments. Even though the investment in the stock options may end up improving the performance of the upper level executives in the company, they may turn to work in opposite direction. For companies that do not use the cash incentive, uses the stock option instead, as a reward to the employees have lower performances (Holtby, Kerr, & Hobbs 2007, pg. 56). For instance, General Motors use such strategy and end up having poor performance. Therefore, options are not the best option to reward the performance of the employees.
The option investment can result to hurt the shareholders. The process of issuing large volume of stock options to the employees can negatively affect the rest of the investors in the company. This is because a large amount of stock issued to the company will result to reduced total earning of the firm. As a result, the price of the stock lowers.
In conclusion, as it is clear that the benefits of the options outweigh the disadvantages, it is clear that the options seem to become the center of the derivative investment. The investor should therefore take these advantages as an opportunity to invest in the future options. These findings show that the option alternatives are able to provide better opportunities to the investors compared to the other investors.
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