Question

For your project for this course, you will write a research paper with a title page, body of at least 4 full pages (double-spaced), and a bibliography page (for a total of at least 6 pages), that discusses the mechanics of stock option trading. In your paper, you should discuss what puts and calls are, as well as different strategies such as spreads, collars, etc. Describe a scenario where a private investor might find option trading to be a beneficial investment strategy.

Answer 1

There can be many scenarios where option trading may be a benificial strategy. One such scenario particularly applicable to a private investor is:

1. When a big movement is expected in a stock's price in near future: If a private investor anticipates a big move in a stock's price he may go long (i.e. buy the option) on the call or put option of that stock depending on whether he is anticipating an upward or downward price movement respectively. Moreover if he is not sure of the direction of price movement but is fairly sure that there will be a big movement in price either up or down, he can go long on a straddle- i.e. buy both Call & Put options of the stock at the same strike price nearest to the current stock price. Such strategies can lead to big gains at low invested capital if the investor's view turn out to be correct without much downside since the maximum loss is limited to the premium paid for the options whereas the maximum gain is (theoritically) unlimited which can be a safe strategy for speculative purpose if planned & executed properly.

2. Another good scenario for a private investor to trade in options would be to protect his stock portfolio against downside risk by buying appropriate number of put options of that particular stock. So even if the stock price falls, the investor would be protected as the value of his put option would increase & net out the loss in the stock portfolio thus protecting the investor's capital.