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Again, index options are much better indicators of the overall market tendencies than individual stock options are for their underlying stocks. With individual stock options, it becomes difficult to get a clear signal, as many of the investors on both sides of the fence tend to be mere speculators .

Final Notes

In this chapter my intention was to give you a good overview of what options are and how they are used by traders. A trader that hopes to profit from options needs to be right not only about the direction of the underlying securities but also about the timing of their move. These requirements render options risky investments, but we also learned about how one can use options to engage in conservative trading strategies such as writing covered calls and hedging. It is important to realize that not all stocks have corresponding options. Options, just like any other type of security, must have a healthy demand in order to exist. If there is no demand for a particular option, there is no option. This is especially true with low-priced stocks. Why would one want to trade options on a penny stock when the underlying security is already risky enough and it is cheap enough to be traded directly in large volumes?

Options are also riskier than futures (the other form of derivative which we covered earlier) as they cannot be rolled over into future options. Once an option is purchased, the buyer has two choices: either settle the contracts prior to expiration, or hold them until expiration. One could, however, simulate a rollover by settling a long option position prior to expiration and then use the proceeds (if any) to buy a future option. Also an option writer (seller) can settle an existing contract just prior to the expiration and then sell another contract with a future expiration date. …