Why retail investors should pay attention to options trading

It can be used as a strategy to protect investments and hedge against losses amid market volatility

Options trading offers everyday investors ways to manage risk, generate additional income and diversify their portfolios. Getty Images

Investing in today’s market is all about options – both figuratively and literally.

For years, options trading has been viewed as too complex for the average investor, often reserved for financial insiders or those with time and resources to explore complex strategies.

But as this once-exclusive area of investing becomes more accessible, options trading offers everyday investors ways to manage risk, generate additional income and diversify their portfolios.

What are options?

At its core, options trading is about flexibility. Options are contracts that offer investors the right, but not the obligation, to buy or sell an asset, such as a stock, at a specific price within a set timeframe.

There are two main types of options: call options, which let you buy a stock at a certain price, and put options, which allow you to sell it at a set price. These two strategies open doors to risk management and profit that traditional stock ownership alone does not.

Building a safety net

With the market’s unpredictability, options can provide a way to hedge against losses. For instance, if you hold stock in a company but worry the market might turn, you can buy a put option as a form of “insurance”.

This option lets you sell the stock at an agreed-on price, so if the stock drops below that price, your option kicks in, limiting your loss.

In addition to individual stocks, options can also be used to hedge broader assets, like index funds or specific sectors, allowing investors to manage risk across an entire portfolio.

This approach is not just for those willing to take big risks. It could also be used as an essential strategy for protecting investments, especially during economic shifts.

By learning to use options as a hedge, even retail investors can feel more secure and reduce the anxiety that often comes with market volatility. It's a form of control that traditional investing doesn't always provide and one of the most effective ways to foster resilience in your portfolio.

Generating additional cash flow

Options can also serve as a way to generate cash flow – a function that surprises many new investors.

Imagine you own shares in a company that you’re happy to hold long-term, but you wouldn’t mind selling them if the price rises to a certain level. By selling a call option on those shares – a strategy called a “covered call” – you grant someone else the right to buy them at that level. If the stock price doesn’t reach your set level, you keep both your stock and the premium paid for the option.

This strategy essentially lets you “rent out” your shares, providing a passive income stream, even if the stock price doesn’t move significantly.

For long-term investors, covered calls can create a potential source of additional returns, enhancing gains beyond just waiting for price appreciation.

Accessibility

Until recently, options trading was mainly the domain of institutional investors and market veterans, as it required resources and knowledge many people simply didn’t have.

However, as technology makes financial information more available, some platforms offer more transparency and education around options trading, allowing retail investors to get involved without needing a Wall Street background.

From video tutorials to reading materials, these resources offer a learning path for investors to understand options step-by-step.

Many platforms aim to break down financial language, so more people can explore strategies that were once seen as reserved for experts. For newcomers, this opens up a new layer of market engagement.

Considering the risks

While options trading opens up new opportunities, it’s also important to remember that this asset class comes with a level of risk.

It’s important to understand the potential downsides, like losing the entire premium on an option if the market doesn’t move as expected.

Prices may not always move as expected, and options involve set timeframes that can affect results. Taking a conservative approach and understanding these dynamics can help new investors to explore options with confidence and balance.

Getting started

For beginners, options trading should be approached conservatively and only after gaining a solid understanding of the risks.

Initial investments should be kept small to manage risk effectively. Always remember that options trading is a specialised area that requires careful consideration and understanding of the risks.

Mark Chahwan is chief executive and co-founder of Sarwa

Disclaimer: Options trading involves risk and may not be suitable for every investor. This article is for informational purposes only and should not be considered financial advice. Before engaging in options trading, it’s essential to assess your financial goals, risk tolerance, and suitability for these strategies.