I understand that buying an option gives you the right to sell a certain stock at the strike price, but what is the point of this? How can you profit from guessing right, and is there any advantages to options that stocks don’t have?
In: Economics
> I understand that buying an option gives you the right to sell
*Certain types* of options that is. Some give you the right to purchase stocks at a certain price in the future for example.
> the right to sell a certain stock at the strike price, but what is the point of this?
If the current price of the stock on the open market is less than the strike price of the option, then you can purchase the stock and sell it immediately at a higher price while pocketing the difference. The point is you make money.
> How can you profit from guessing right
Beyond the obvious situation explained above, options are also useful for something called “hedging”. Basically they are mechanisms to avoid risk. If you are in a situation where you want to potentially profit from a stock you own going up in price but if it went below a certain price it would be disastrous, you could purchase an option to sell at a price just above that point. Now the maximum amount of money you could lose from the stock value changing is limited.
> is there any advantages to options that stocks don’t have?
Again, in addition to the above situation of hedging you could potentially trade in options without tying a lot of money up owning stocks themselves. For example if we consider the situation where you purchase the option to sell at a certain price, betting that the stock will reduce in value, you don’t have to keep a bunch of money invested in owning the stocks themselves in the interim. All you spend is purchasing the option and that is going to be far less than the cost of the stocks themselves.
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