investors to either accept or transfer risk. The options market is
technically a market for dealing in risk. You’re probably wondering
who would ever want to willingly accept risk. Odd as that may
sound, we do it all the time. When you buy an auto insurance
policy, you are paying a fee to the insurance company. In exchange for that fee, it is
accepting the risks associated with you having an accident. The insurance company
is
accepting risk in exchange for cash. You are paying cash in exchange for transferring
the unwanted risk. The agreement between you and the insurance company creates
an intangible market – the market for risk. So to answer the question of who would
ever willingly accept risk, you must remember that someone is getting paid to
accept that risk. If the fee is high enough, you can be sure that someone will step
in and accept the risk.
This highlights why the options market is perceived to be so risky. After all,
it is a market whose only product for sale is risk. As stated before, the riskiness of
options depends on how you’re using them, but now we can state it a little more
clearly: It depends on whether you are transferring or accepting risk. None of us
would consider the car insurance market to be risky since we use it to transfer risk
away from us. However, the insurance companies see it quite differently. It depends
on which side of the agreement you’re on.
The options market works a simple principle: While many investors wish to
reduce risk, there are some people who actively look for risk. The latter are called
speculators
. Speculators are willing to gamble for big profits; they aren’t afraid
to take a long shot if there is potential for big money. People who patronize
casinos and play state lotteries are acting as speculators. If there are speculators
out there who are willing to accept risk in the stock market, wouldn’t it make
sense to be able to transfer it to them? Of course, in order to make it worth their
while, we will have to pay them some money to accept that risk. So if there is
a risk you wish to avoid, you can do so by purchasing an option. Conversely,
if there is a risk you’re willing to assume, you can get paid through the options
market to accept the risk for someone else. So while one investor may be using
options to avoid risk, it is possible that the person on the other side of the trade
is a speculator willing to accept that risk. Investors who do not understand this
interplay between investors and speculators hear both sides of the story and that’s
where the confusion comes in.
Unfortunately, this confusion often makes many investors avoid options
altogether. This is a big mistake in today’s marketplace. As our economies expand,
our financial needs increase; That’s why you see so many new financial products
coming to market. Each product is different – sometimes only in small ways – but
each provides the solution to a specific problem. Options allow you to selectively
pick and choose the risks you want to take or avoid.
And that is something that cannot
be done with any other financial asset
. Because you can select the individual risks
to take, options can be used in very conservative as well as very speculative ways.
It’s all up to you. If you’d like to make the stock market a less risky place, options
are your answer. If you’d like to increase the risk and speculate more efficiently for
bigger profits, options are your answer too.
Let’s get started and find out how you can improve your investments from this
mysterious market.
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