Speculation
To speculate on options may appeal if, as an investor, you want a fast return, and are prepared to take risks to achieve it. To give yourself the best chance of success, you will need to watch the market continuously. Options are a highly liquid market, and you will usually be able to complete your trades.

Speculation through options trading is not gambling but is all about taking a calculated risk. For every buyer of an option there is a seller, but neither side has the odds intrinsically stacked in its favour.

Hedging
You can use options to hedge a position that you may have in a share or index. Hedging is different from speculation in that it is about protecting your existing position rather than making a profit. Let us look at an example of a hedging technique. If you believe the market will crash, you can buy Put options for a company in which you hold shares. This way, if the share price crashes, you can compensate by selling the Puts for a profit, and will have effectively insured your position.

Two bullish strategies
If you think the underlying security or index will rise significantly in the short term, buy a Call option. You may foresee such a rise if, for example, the underlying company has just become the target of a takeover bid or there are rumours to that effect.

A riskier alternative strategy is to become the writer of a Put option. This way, you will receive the premium from the buyer. Usually, the Put option sold will expire worthless, and you will keep the premium (10-15 per cent of the gain) without having to buy the underlying stock.

However, if the share price falls below the exercise price (plus the option buyer’s dealing expenses), you stand to lose money. The price of the underlying share cannot fall below zero pence and so your maximum loss will be the full value of the share. City professionals do not like writing Put options. I know of a City trader who lost a fortune this way at the start of the market correction of high-tech stocks in March and April 2000, although, in all fairness, some have fared a lot better.

Two bearish strategies
If you think that the company’s share price will fall hard, your simplest strategy is to buy a Put option. As an alternative, you could write a Call option. If so, you will take the premium from the buyer, which is the main attraction of the deal, and you will keep it if, as usually happens, the share price does not rise above the exercise price (plus the option buyer’s dealing expenses). If the share price does rise above this level, you are faced with a theoretical unlimited loss because you will have to provide the shares at however high a valuation they have reached.

If you are writing a covered Call, you will own the shares already and will simply provide them without any further cash outlay. What is riskier is when you have written a Naked Call, which means you do not own the underlying shares. If the share price collapses, you will then have to buy shares at the prevailing market price to keep your part of the deal. The same principle applies in reverse to writing Puts (see above).

Straddle
A common option trading strategy is a straddle. Use it when you expect the underlying stock to move significantly, but you don’t know in which direction. In a long straddle, you will buy a Call option and Put option at identical exercise prices and expiration dates. It sounds a wonderful compromise. The catch is that the share price has to move up or down a lot - to get past the expense of two premiums rather than the usual one (as well as the high commission costs applicable to a straddle) - if you are to make money.