This leads to the third advantage of options. The option position is less risky once the total dollar risk between a stock position and an option position is balanced. In the paragraph above, we showed the true hedging nature of options. Extending this a bit, we can see that options come with their own built –in hedging component. However, there are risk calculations you must learn to balance the total amount of dollar risk between the two strategies. Once that is accomplished, you realize that the Stock Replacement strategy is safer than an outright stock purchase. Since you can only lose what you spend in options (option buying), the option position is safer than the stock position. Remember our previous example about XYZ stock. Suppose you had decided to purchase the 55 strike call for $10.50. If the stock was then to gap down to $40, you would only lose the $10.50 you spent on the option as opposed to the $25.50 that the stock position lost. Again, it is important to realize that you will be paying out a little time premium to own the option, but when executed properly, it is normally pennies compared to what you could lose in the gap on the stock. Think of this strategy as a little insurance policy that protects you against catastrophic losses.

The fourth advantage of options is cost effectiveness. You can find an option that mimics a specific stock’s movement 90-100% yet costs only a third (or even less) of the actual stock. This means you spend less money while maintaining a similar dollar position. The key is to learn what option to choose and when to choose it. Just think about it. You can develop the ability to gain the same dollar return on your position while spending less money. That translates into higher returns on investment (ROI) and more importantly, more capital in your account to use in other places. Again, there is a skill needed to select the right option for what you want to accomplish. That skill is learned in a strategy called Stock Replacement. You must first understand the strategy and then learn the process for selecting the correct option to fit your opportunity.

Another advantage of the option is flexibility. Options are infinitely more flexible than stocks and may be employed in many ways. First, options allow you to trade not only an up market and a down market, but also a sideways market by trading volatility or time decay. Although stock traders can trade a down market as mentioned earlier (shorting stock), they cannot trade a sideways or stagnant market. However, there is a way for an option trader to trade in a sideways market. As a matter of fact, there are several ways. This leads us to another flexibility advantage of options: the ability of options to take advantage of a situation in multiple ways. For a stock trader, the only way to take advantage of a stock going up is to get long the stock….buy it.

Option traders can use the Stock Replacement strategy, the Covered Call strategy (if they want to buy the stock) plus a number of different spreads. These strategies require different levels of capital, have different risk scenarios, and offer different amounts of reward. No matter what your capital, your risk tolerance level, or what your style and philosophy, you will find an option strategy that fits you and your identified opportunity. The flexibility of options even extends to what you can do once you are in a position. Options easily allow you to continue a position out into the future (roll) when things remain the same, totally change the position on the fly (morph) when the opportunity you are in changes, and with the understanding and proper use of synthetics, close the position in more than one way. Options are the most flexible trading instrument out there.