Trading Master Class With Experts

Risk and Reward in Options

Options provide defined risk for buyers and potential risk for sellers:

Buyers: Maximum loss = premium paid, profit = theoretically unlimited for calls, limited for puts.

Sellers (writers): Maximum profit = premium received, risk = potentially unlimited for uncovered calls, high for puts.

Example:

Selling a call without owning the stock (naked call) can lead to unlimited losses if the stock skyrockets.

Buying a put limits risk but can still profit from sharp downward moves.

Hedging with Options

Options are a powerful tool for hedging investments:

Protective Put: Buying a put on a stock you own protects against a decline.

Collar Strategy: Buy a put and sell a call to limit both upside and downside risk.

Portfolio Insurance: Large investors use index options to protect portfolios during market volatility.