Options are very useful trading instruments that many traders try to take advantage of. Here are the top  main reasons why they use options.

Speculation

Speculation is a bet on future price direction. A speculator might think that the price of a stock will go up, perhaps based on fundamental analysis or technical analysis.

A speculator may buy the stock or buy a call option on the stock. Speculating with a call option – rather than buying the stock outright – is appealing to some traders since options provide leverage. An out-of-the money call option may only cost a few dollars or even credits compared to the full price of a $100 stock.

The leverage component of options contributes to their image as being for being risky. It is important to understand that when you buy an option, you must be right in the direction of the stock’s movements, as well as the magnitude and timing of this movement.

In other words, if you want to succeed, you must correctly predict whether a stock will go up or down, and you have to correctly predict the time frame in which all of this will happen.

Hedging

Options were really created for hedging reasons. Hedging with options is meant to reduce risk at a reasonable cost. As such, you can think of options are insurance policies since options can be used to insure your investments against a downturn.

Some critics may say that if you’re so doubtful of your stock pick that you still need a hedge, you shouldn’t make the investment.

In reality, you can find a lot of evidence that hedging strategies can be useful.  This is particularly true for large institutions. The individual investor can also benefit from hedging.  Using options let you limit your downside risk and enjoy all the upside in a cost-effective way.  For short-seller, using call options can help them limit losses if they’re wrong.

Spreads

Spreads use two or more options positions of the same class. They mix having a market wager (speculation) with limiting losses (hedging). Spreads usually limit potential upside as well. Yet these techniques can still be desirable since they usually cost less when compared to a single options leg.

Vertical spreads involve selling one option to buy another. In general, the second option is the same type and same expiration, but different strike. Spreads really exhibit the versatility of options. A trader can create a spread to profit from nearly any market outcome. This even includes markets that don’t move up or down.

Combinations

Combinations are trades created with both a call and a put. There is a special type of combination referred to as “synthetic.” The idea behind a synthetic is to create an options position that behaves like an underlying asset, but without actually controlling the asset.

For instance, if you buy an at-the-money call and simultaneously sell an at-the-money put on the stock with the same expiration and strike, you have created a synthetic long position in XYZ stock.

You don’t really own the stock since you have never bought it, but the combination of your long call and short put behaves almost exactly like owning stocks.

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