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Options also give their holders yet another important benefit: staying power. Remember in our discussion of futures, the contract holder may be forced to replenish his account or settle his contracts if the underlying commodity moves beyond an unfavorable limit. Not so with options. An option contract holder can hold onto her contracts all the way to the expiration date without having to come up with extra funds or settle. The most she would lose is the price of the option contracts and the corresponding commissions she paid. And this is known as staying power, an important benefit of options. Of course for every advantage there must be a disadvantage. With options the risk of loss is usually much greater than that of any other kind of instrument. The other risk is that while profit potential for an option is high, a favorable move in the underlying stock may not necessarily translate to an equally favorable move for its corresponding options. Other factors may hamper such movement for the options or may even cause it to move unfavorably. Only when all factors are optimally present, would an option position become profitable. We will cover these factors as we go on.

The Long And Short Of It

We have covered the concepts of long and short positions before. These concepts also apply to options. When you buy an option contract you are long one contract. When you sell (or write) a contract you are short one contract. In order to fully settle your position you must take the same size but opposite position of your original position. In other words, if you are long five contracts (you have bought five contracts) and you want to fully settle your position, you must go short five identical contracts (i.e., sell the five contracts). Conversely, if you are short eight contracts, you must go long eight identical contracts (buy the same eight contracts you had previously sold) to be fully settled. As always, partial settlements are also possible. If you are long 14 contracts …