August 2, 2007

Options: Another tool for investors

Options are relatively unknown to the individual investor. They tend to be used mostly by hedge funds and other institutional or big-money investors. However, options are much easier to trade now than they have ever been. Online brokerages now allow for option trading by individuals at low commissions, and there are now even specific brokerages that deal mostly in options trading like OptionsXpress.

I find options very intriguing. And I think every investor should have some knowledge of options, so that they have more (for lack of a better term) options when investing. There are three main purposes of options. 1. Speculation; 2. Hedging; 3. Income

For our purposes, the use of options with biotech stocks, especially small biotechs, is generally limited to speculation, which is what I'll focus on here. For more information on options, there are several great web sites out there. Personally, I like Investopedia and 888options.

Many of the biotechs I've focused on in my blog have been very small companies, with little or no revenues, and not even a hint of a profit yet. In other words, very high risk stocks for investors. Instead of investing directly in some of these companies, we could instead purchase call options. However, not all of these small biotechs even have options trading. For example, I have talked recently about GenVec (GNVC), Neurogesx (NGSX), and Ziopharm (ZIOP), all of which have potential for stock price appreciation, but also could be subject to price declines based on their clinical trials and the potential of their drugs gaining FDA approval. Personally, I would rather use options, but none of these stocks have options trading because of their size.

I think options would be a great way to play stocks like these (if they were available) and other small biotechs because they can take out some risk. Options give you the opportunity to participate in stock gains (call options) or stock losses (put options) without using as much capital as would be necessary to actually buy the stock or as much risk as shorting. However, if options expire out-of-the-money, options owners will lose their initial investment in the options. But, that could be an acceptable loss when dealing with small biotechs.

For example, lets say Family Biotech Inc. has a drug in Phase III trials and the data should be released soon. As an investor, you think FBI's stock could go either way depending on the data and the stock price move could be very significant. You wouldn't want to buy the stock because the data has just as good of a chance to be bad, which would send the stock down significantly. This is where options are good. You could buy calls and/or puts, which would give you exposure to the stock price move without buying the stock.

Being able to understand options and having the ability to use it as another investing tool can open up avenues to better returns for investors. However, there are risks associated with options that are different that just buying stock. Investors should educate themselves first with options before trying their hands at it.

This was only an introductory post on options. Options will be another area that I will be tracking in future posts. I plan on finding some potential investments in small biotech that have options to trade, so that I can provide you with more avenues to better returns.


Disclosure: I own shares in NGSX, however, at the time of writing this article I did not. I do not have positions in any of the other stocks mentioned.

19 comments:

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