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Lesson 6. Stock Derivatives > Options - Pg. 31

Stock Derivatives 31 "Wait," you say, "Didn't you tell me in the last section that the price of stock will almost always go up eventually? So, I should just hold on to those options until such time as the stock does finally go up. Right?" Well, in theory the answer is yes. But to even the playing field, options have a limited time within which they must be exercised, or else they expire. The date when they expire is known as the expiration date. Although this term is not a particularly technical one, it is worth noting because it does limit the time within which an investor has a chance of making money off the option. As noted earlier, an investor can often make more money with options than with an actual purchase of stock. However, the risks rise proportionately. The limited time frame and the increased effect from changes in the price of the stock are summed up in a term called volatility. Caution Volatility simply means that the more money you potentially can make with your investment, the more risk you run of losing your money. It is because of this increased volatility that options can be dangerous--even for seasoned investors. For example, about three years ago I personally held several hundred options in a company, which were worth thousands of dollars. I kept meaning to convert the options to actual stock, but every time the stock rose a point, I made 10 times more profit than I would have had if I actually owned the stock itself. Those kinds of gains are really addictive, even to a seasoned investor like myself who knew the risks. At any rate, I never did convert the options. The day the Russian ruble collapsed, the underlying stock value dropped by half. This was disastrous for the stockholders because their stock lost half its value. However, I, as an option holder, was completely wiped out because the price of the stock had dropped below the strike price. My options were therefore completely worth- less. Upset and in tears, not to mention broke, I called my parents to bemoan my disaster. That memory keeps me out of the options market, but you'll have to decide for yourself what your toler- ance for risk is and act accordingly.