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Why Trade Options

There are three main reasons why traders may wish to trade options:

1. Portfolio Protection: Investors can use options to help protect a portfolio of stocks against sudden downward pressure. This is a very conservative strategy where puts are bought to act as a hedge. Investors thereby buy the right to sell stock already owned at a particular price (the strike price) - regardless of what the market is doing. If the price of the underlying stock continues to rise instead of falling, this strategy will limit the portfolio's upside potential (reducing it by the cost associated with the purchase of the puts);
2. Generate Additional Income: Another conservative options strategy is sell calls while owning the underlying stock. This is called covered call writing; it is a strategy often used by investors to generate additional income on stocks already in their portfolio. This strategy provides limited downside protection in case stock prices fall. If stocks fall only moderately, the covered call writer can cushion the blow of a decline as he or she is entitled to the premium received for selling the calls; however, if stock prices drop strongly, investors will still lose money because the premium received for the calls will not offset the mounting losses in the underlying stock(s);
3. Speculation: Investors with a high level of risk tolerance may wish to leverage relatively moderate sums of money. Buying options is associated with rights but not obligations. Traders may purchase calls with the expectation that they will be able to sell these later at a profit - if the price of the underlying security goes up. Speculators buying call options (or selling put options) hope to profit from rising prices. Traders may also buy puts in the anticipation of selling them later at a profit - if the underlying security drops in price. Speculators buying put options (or selling call options) hope to profit from declining prices. Because speculators may not own the underlying equity, they risk losing substantial amounts. If a long option expires worthless, the options buyer cannot lose more than the amount paid for those options plus commissions. On the other hand, speculators who sold (wrote) options can lose significantly more than  the premium they received for selling them.

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