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What are the Benefits & Risks?

Options involve risk and are not suitable for all investors.
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
Most strategies used by options investors have limited risk but also limited profit potential. Options strategies are not get-rich-quick schemes and can also have unlimited loss potential.
Transactions generally require less capital than equivalent stock transactions. They may return smaller dollar figures but a potentially greater percentage of the investment than equivalent stock transactions.
Select to close help pop-up A short call option in which the seller (writer) does not own the shares of underlying stock represented by his or her options contracts or an offsetting long call options contract. If assigned, the seller is obligated to deliver the underlying security at the strike price. As the writer does not own the underlying security, the writer may have to purchase the underlying security at any price in order to meet the obligation. This represents unlimited risk as the underlying security has unlimited upward potential.
Although options may not be appropriate for all investors, they're among the most flexible of investment choices. Options can be used to apply a bullish, bearish or neutral strategy and utilized for generating income, hedging or speculation.

Reducing Your Risk

For many investors, options are useful tools of risk management. They act as a hedge against a drop in stock prices. For example, if an investor is concerned that the price of their shares in LMN Corporation are about to drop, they can purchase puts that give the right to sell the stock at the strike price, no matter how low the market price drops before expiration. At the cost of the option's premium, the investor has hedged themselves against losses below the strike price. This type of option practice is also known as hedging with a protective put.
While hedging with options may help manage risk, it's important to remember that all investments carry some risk. Returns are never guaranteed. Investors who use options to manage risk look for ways to limit potential loss. They may choose to purchase options, since loss is limited to the price paid for the premium. In return, they gain the right to buy or sell the underlying security at an acceptable price. They can also profit from a rise in the value of the option's premium, if they choose to sell it back to the market rather than exercise it. Since writers of options are sometimes forced into buying or selling stock at an unfavorable price, the risk associated with certain short positions may be higher.
Many options strategies are designed to minimize risk by hedging existing portfolios. While options act as safety nets, they're not risk free. Since transactions usually open and close in the short term, gains can be realized quickly. Losses can mount as quickly as gains. It's important to understand risks associated with holding, writing, and trading options before you include them in your investment portfolio.

Risking Your Principal

Like other securities including stocks, bonds and mutual funds, options carry no guarantees. Be aware that it's possible to lose the entire principal invested, and sometimes more.
As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise.
Since initial options investments usually require less capital than equivalent stock positions, your potential cash losses as an options investor are usually smaller than if you'd bought the underlying stock or sold the stock short. The exception to this general rule occurs when you use options to provide leverage. Percentage returns are often high, but percentage losses can be high as well.
Content licensed from the Options Industry Council is intended to educate investors about U.S. exchange-listed options issued by The Options Clearing Corporation, and shall not be construed as furnishing investment advice or being a recommendation, solicitation or offer to buy or sell any option or any other security. Options involve risk and are not suitable for all investors.

Content licensed from the Options Industry Council. All Rights Reserved. OIC or its affiliates shall not be responsible for content contained on Merrill's Website, or other Company Materials not provided by OIC. OIC education can be accessed at the OIC web site popup.

Without the Jargon

Options trading is not for everyone and it is important to understand the risks involved – especially since options are a decaying asset. There are varying degrees of risks involved with options that are dependent upon the strategy. For example, the purchaser may buy 1 ABC 100 Call at a premium of $8.00. This call contract gives the purchaser the right to buy 100 shares of ABC at $100.00 per share at any time before expiration at a total cost of $800.00. Because the purchaser owns the call, the purchaser also owns the right to exercise their right to buy at 100 shares of ABC at $100 per share at any time – the choice to exercise is at the buyer's discretion. Therefore, the purchaser's loss is limited to $800.00 regardless of how far up or down ABC moves.
On the other hand, the seller who sold 1 ABC 100 Call at a premium of $8.00 has much greater loss potential. If ABC increases to $125.00 and the purchaser decides to execute the terms of the contract, the seller has the obligation to sell the purchaser 100 shares of ABC at a price of $100.00 when the buyer decides. The seller needs to purchase 100 shares from the market at $125.00 in order to meet the obligation. This strategy has unlimited loss potential from the seller's point of view as ABC can theoretically increase infinitely.
Information not provided by the Options Industry Council
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
View definitions for investment terms in our Glossary.
The material was provided by a third party not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.
For purposes of all the computations discussed in this article, commissions, fees and margin interest and taxes, have not been included in the examples. These costs obviously will impact the outcome of any stock or option transaction. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
This material is being provided for informational purposes only. Nothing herein is or should be construed as investment, legal or tax advice, a recommendation of any kind, a solicitation of clients, or an offer to sell or a solicitation of an offer to invest in options. The information herein has been obtained from third-party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed.

Supporting documentation for any claims, comparisons, recommendations, statistics or other technical data will be furnished on request.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
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Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.

Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets.
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