Options as an Investment
Just like with futures and other securities, money is made if you buy an option and later sell it at a higher price, or sell an option and later buy it back at a lower price. Options have some attributes, though, that make them different than futures as an investment and, for some traders, preferable.
Limited Downside Risk:
Buyers of options, whether a call or a put, have limited downside risk: The most that they can lose is the premium paid for the option, plus commissions. If prices move adversely after option purchase, the holder will simply let the option expire worthless (without exercising it). Buyers of a futures contract, on the other hand, have no such protection. If prices move adversely after the futures purchase, the holder suffers all losses until the position is closed. While option buyers have limited downside risk, option sellers do not since an option seller must enter into a transaction at the discretion of the option holder, no matter how adversely prices have moved. For this reason, selling options is considered riskier than buying options.
Option Expirations:
Options are either exercised or allowed to expire worthless. Options will only be exercised if it is in the financial interests of the holder to do so. If an option is left to expire worthless, it is the option seller who benefits as they were able to earn the full premium of the option that was received when the option was sold. An option that expires worthless also enables the option seller to get out of his short option position without having to initiate an offsetting transaction. By contrast, a seller of a futures contract can only get out of this position by offsetting it with another transaction, or actually making delivery of the underlying interest.
No Price Limits:
Markets for options on futures typically do not have price limits, even if the futures market operates with price limits. As a result, an option trader will not face a locked-limit market.
Variety of Strike Prices:
Options are listed with a variety of strike prices, usually selected to straddle the market price of the underlying futures contract. Because strike prices differ, the premium of these options will also differ - some will be more expensive than others. This provides a lot of flexibility to the option trader. For instance, the call option buyer who is willing to risk only a small amount of money can buy a call option with a high strike price as it will havea relatively low premium.
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