When it comes to diversification, there’s no real question as to whether it’s a good idea or not. It’s the surest way to protect yourself from a volatile market and it’s a given that successful portfolios should opt for this most basic of risk management strategies, but complications may arise when it comes to putting the concept into practice.
That’s because diversification can take all sorts of forms. The reality is that there are dozens of different investment instruments to consider, with each of them having their own unique qualities to recommend it.
Options trading is just one of many potential paths to take, but it can certainly be a wise choice for those who use it well. If you’re wondering whether it could be a good option for you, let’s examine the idea in a little more detail.
What is options trading?
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Even experienced investors may lack an in-depth understanding of certain investment markets, so if you’ve never tried it before, you might be asking yourself one very important question: what is options trading, and how could I use it?
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Essentially, options work by giving you the ability to trade on the future value of a market. When you purchase them, you’re purchasing the right to trade at a set price and before a set date. However, unlike similarly functioning futures, you have no obligation to act on this contract.
The simplest way to explain this is with an example. Let’s imagine you hold an option to purchase silver for $1,000 until the end of June. If the price rose to $1,500 during this period, you could buy the product for $500 less than the market value. However, if it remained below this threshold, sticking at $995, you could opt to buy it at the lower price and not exercise your option.
Diversification: using options to hedge
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Any type of investment instrument can be used as a means of diversifying your portfolio and spreading your risk across different markets, but not all of them can be utilized in quite the same way as options.
You see, the idea behind diversification is that possessing a variety of investments will act as a buffer against market volatility, but options allow you to go one step further by hedging your bets and safeguarding yourself against losses.
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In fact, options trading was originally envisaged with this specific purpose in mind. It essentially gives investors the opportunity to play both sides of the field. Imagine, for example, that you’ve purchased stock in a company, but that you lack confidence in its ability to hold its value. Options can counteract this risk, by allowing you to purchase the option to sell your stock at a price at or just below that which you paid for it in the first place. This means that if its value takes a tumble, you can act to limit your losses and protect the overall value of your portfolio.
An ideal tool for building a strong and sustainable cache of assets, options trading can most certainly be used to your advantage. The ultimate choice for diversification in many respects, it should be utilized wisely to safeguard your assets, while also forging ahead with other, less risk-averse additions to your portfolio in order to create the perfect balance between profit and protection.
