Funds and Options


Funds and Options

Trading options is risky. While the risk is limited to the cost of the option (the 'premium'), that isn't necessarily small. A Google June 400 call can cost around $2800.

The premium may be only 28, but an option contract is a commitment for 100 shares. Hence the figure is multiplied by 100. Of course, for that commitment the buyer is controlling roughly $40,000 worth of stock. ('Roughly' since the strike price, $400, differs from the current market price, say $395 at the time of the contract.)

Options, by nature, have an expiration date. (That's part of what makes them an option.) As that expiration date draws near the worth of that option can rapidly approach zero, depending on the current market price and other factors. Hence, risky.

And that scenario only involves controlling 100 shares - not much in the scheme of things.

One way around these difficulties is to invest instead in a fund. Funds invest in stocks, bonds, commodities, indexes, even futures or options - all the things individual investors themselves trade.

Investors who purchase a fund (a mutual fund or 'open-end' fund) own a portion of the instruments the funds buy. The fund is managed by a fund manager, presumably a knowledgeable and experienced investment professional. The fund manager has (in theory, anyway) the available resources, time and expertise to make investments that garner returns superior to what the individual can make himself.

The investor in mutual funds pays a fee for the service, but gets not only expertise and resources but also the advantage of being able to pool funds (hence the name) with other investors. That pooling allows control of many more shares, bonds, etc than the average individual can.

This helps influence prices in that fund's direction. (If you don't think so - and considering that many of them lose money skepticism is warranted - look at a chart showing price fluctuation against daily quantity bought or sold by the larger funds. There's no question that large funds influence stock prices, which in turn can influence their fund's value.)

For those investors interested in options, but without the time, expertise or capital to profit from them options funds are available.

Make sure you study carefully what the fund actually offers, though. There's a difference, sometimes overlooked, between an option on or from a fund and a fund that buys options.

Some funds actually purchase options contracts and speculate just as individual options traders do. Since funds control a larger amount of capital than individual investors the 'multiplier effect' (leverage) of options investing is increased further.

Other funds, though, actually buy stocks and then issue options to the fund members on those stocks. That's a different animal. This can produce profits for participants, but are more like short term trades. As the share price rises, the options are just exercised, limiting income growth opportunities.

Mutual fund investors tend to be more interested in the long-term outlook and often seek income growth funds.

The same variety of options available to the individual are, of course, there for the fund manager. Options on stocks, bonds or commodities are commonplace, but one of the newer wrinkles is options on ETFs (Exchange Traded Funds).

Funds that invest in these are actually speculating by buying an option on a fund that's gambling on an index that measures a basket of stocks. If your head hurts - and who could blame you - maybe you should just buy stock.


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