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OPTION TRADING STRATEGIES .
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Option Income Position w/Adjustment

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OPTION STRATEGIES FOR INCOME vs SPECULATION

Options Trading For Income vs. Speculation

There are many different ways to trade options. Options have many uses including use as a hedging instrument, a vehicle with which to trade markets directionally, or as a vehicle to trade volatility. In the world of options trading, people generally fall into one of two camps:

Those that trade options to speculate and those that trade options as part of an income strategy. There is no right or wrong here-people choose options strategies based on many factors. Let's take a closer look at these two types of options trading and see some of the pros and cons of each.

Option Income Traders

Options can be utilized as a potential income source in many different ways.

For example, if one owns shares in a particular stock, he or she may write covered calls against the long stock position in order to try and achieve more return and help protect one's downside to a degree. Conversely, one who is short a stock may elect to sell puts against his or her short position.

Options may be used in many income strategies in which one does not own the underlying at all. The iron condor, for example, is a very popular strategy among retail investors and pros alike.

The iron condor is constructed by selling out-of-the-money call spreads and put spreads on the same underlying. In this case, one is looking for the underlying to trade within a specific range during the life of the options. One can potentially make money with such a strategy if the underlying stays within that range until the options expire worthless. In this case, the option trader would keep the premium collected when he or she initiated the position. One should keep in mind, however, that one can accrue losses as well if the market does not stay within the specified range.

There are, of course, many other strategies that can be used in this manner such as calendar spreads, butterflies, short calls or puts and more. The primary benefit of option income strategies is that they allow one to potentially profit from theta, or the passage of time, and changes in implied volatility. This can make income strategies appealing to people as they may be more 'hands off" than many other approaches.

The primary downside of option income strategies is the potential for very large losses. When one sells naked options the loss potential is unlimited. One should carefully examine his or her financial circumstances and experience before engaging in such strategies as the risk of loss always exists and therefore these strategies are not suitable for all investors.

Speculative Options Trading

Options may also be used as a vehicle for speculation. When one buys an option whether a call or a put, his or her market exposure is limited to the premium paid for the option. Regardless of what the underlying does, one cannot lose more than this amount when buying options. This is very comforting to investors.

There are several possible reasons one may use options to speculate. A great example is betting on a high priced, high flying stock. Perhaps one is looking at shares of company ABC which is currently priced at $900 per share and is very volatile. One might be uncomfortable with buying this type of stock outright or on margin, and therefore may elect to buy an option instead knowing that their risk is limited to the premium paid.

Another reason options may be used is to try and stay in a position without the risk of getting stopped out on a pullback or "shakeout." Options may also be bought to speculate on volatility.

One can potentially make money on long options if there is a large enough increase in implied volatility levels all else remaining equal. While buying options to speculate has some benefits, it also has some drawbacks.

These drawbacks include the option's exposure and vulnerability to time decay, the potential for option values to deflate based on a drop in implied volatility, and the underlying not moving enough to generate a profit on the position.

As with all types of trading and all strategies, there is no free lunch whether one is using income strategies or using more speculative strategies. What is right for one investor may not be right for another investor.

One should carefully examine his or her options experience, financial circumstances and objectives before engaging in any type of options trading.

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