Trading options often strikes beginner investors as a scary prospect, but it doesn't have to be. Options generally have more risk than more conservative investments, but that usually comes with a higher rate of return for the investments that pay off. If you're new to investing and wondering whether options can be a good choice for you, it helps to learn all you can in advance.
What is Options Trading?
Options are a third type of investment, after debt (think buying bonds) and equity (stocks, commodities, etc.). An option is the buying and selling of contracts, which are themselves about other people's buying and selling. Say, for example, somebody had cows to bring to market, but nobody was buying beef, you can buy the option for beef futures and then sell the contract when another party shows up looking to buy. In this case, you just bought the rancher's promise to deliver cattle and sold it to the processor who can turn it into hamburger, ideally without having any actual cattle delivered to your office.
Taking a Balanced Approach
Trading options is effectively buying and selling the risk of other contracts. The cattle rancher needs you to take some of the risk that nobody will buy beef, while the buyer needs you to eliminate the risk that nobody will be selling when he gets to the market. The premium you can charge for this service is your reward for smoothing out the transaction as a purchasing/selling agent for both parties. Risk is always risky to carry, so options are generally best when they're part of a generally diverse portfolio that includes stocks, bonds and index funds.