Options and Their Role in Increasing Equilibrium
Investors, both big and small, are attracted to stock options because of four factors -- absolute risk, the ability to play both directions of a market, the opportunity to buy time, and very high leverage (Mackevich, 1984). While all are significant, the most important is leverage. For a small amount of money, stock options investors can control hundreds of shares of stock, and their profits are leveraged accordingly -as is their risk, of course. Yet, when the market is moving rapidly in either direction, such investors count their gains in thousands of percentage points.
For such gains, the options investor pays a price in increased risk. While timing is important in standard stock transactions, it can be the key for options holders (Mackevich, 1984). While options allow the investor to buy time, this feature means he or she is also playing against a clock. However, because the options investor is buying time -- locking in a purchase or sale price of a specific stock for up to nine months -- options offer small and big investors alike an equal opportunity to fine tune their investments.
Investors can also profit with options from a relatively small investments, and with them, one can play either direction of the market with equal success (Mackevich, 1984). For many investors, the most appealing feature of options is predetermined, absolute risk. Such investors know, from the start, exactly how much money is at stake. The maximum that can possibly be lost is the price paid for the options, which is considerably less than in most standard stock transactions.
Like any other investment, options are not appropriate for everyone (Hert, 1986). However, well-defined the risk is, options buyers have only a specific amount of time in which the underlying stock must move in the direction they expect, so the risk is quite real. Nevertheless, stock options can be a highly us...