Taking The LEAP Into Stock Options

Reserving the right to purchase stock later offers both risk and reward. Here's how to carefully get a handle on it all.

Novice or longtime investor, if you’ve been pondering buying stock over the last year or so, you’re bound to have wrestled with one gut-wrenching dilemma: how can you have your stock and profit too? Maybe you’ve fallen for a company. You think its product is a godsend and its management are prophets. The problem is the stock market seems to have come to the same conclusion a couple of weeks before you did, and a stampede of investors has pushed the shares up to the stratosphere. Do you buy in now or wait and pray that the stock comes down a bit before you jump in?

Then again, you might pick up the newspaper and see that a company just saw its stock tank, although its business still seems sound. Do you snatch up shares at a bargain price or wait until things are better? Or maybe after a good bit of homework, you’re puzzled. Market guru after market guru is saying stocks are, if not overvalued, then close to being priced too high. You’re ready to invest now. So what do you do?

These kinds of seemingly no-win situations are cropping up a lot these days. And in each case, there’s no doubt you’d be a lot more at ease with some kind of marker, some way to put a down payment on a stock without risking every last cent you have decided to invest. Then you could stand back, let time pass and see if your hunches, whether good or bad, came true.

For a lot of people these days, the answer to these sticky choices is options, an investment that simply amounts to an agreement or contract to buy a specific number of shares at a fixed price at a certain date. That’s because options allow an investor to reserve a piece of the action for the future. In other words, options investing can be a hedge against things turning sour later. “Under the right circumstances, you can think of the options market as a way to buy synthetic stock,” says Dain Rauscher broker Pete Seeley.

That might seem hard to believe particularly after the scare over derivatives, a shock driven home by imprudent investments by the government of Orange County, California, a few years back. As we’re all aware, options for the average investor have existed on the periphery of safe, sound money moves. That’s because options carry a value of their own, one that can swing wildly upward or downward depending on how the stock they’re tied to fares. They might be a shade less frightening than some of the hairier derivatives out there, but when you get down to it, they’re far spicier and more risque than the average armchair investor is willing to stomach.

That hasn’t kept individual and institutional investors alike from piling into the options market. According to statistics compiled by the Options Industry Council, a Chicago group that educates investors about options and monitors the industry, volume in the equity options market increased 37%

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