When choosing to invest in a company there are three options available to an investor. They can purchase company stock, bonds, or options. Bonds are the safest way to invest, but also has the lowest rate of return. It’s basically a loan where the company borrows money from you and later returns it to you with interest. On the another hand, buying stock is the same as buying ownership of a company. This means that if the company grows, then the stock will grow as well, while the bond will still return the same amount- its interest. An even riskier way to capitalize on a company’s growth is to buy options, which is a right to buy or sell a stock at a certain price. If the company stock grows to 300 and I have an option to buy the stock at 250, I can exercise the option, buy the stock at 250 and then sell at 300 for a 50 profit. This is also the riskiest because if the stock drops below 250 on the expiration date of the option, the option will be worthless(in other words, you’ve lost all your money). But options aren’t just for those looking for risk. Options can be a good hedge for your portfolio to reduce the effect of drawdowns on stock you own, for example buying SPY puts to protect your portfolio of SPY.

The past few months, SPY has fallen from its high of over 290 and is now sitting around 255. If you owned SPY call options during this period, you will likely have suffered great losses. If you held SPY during this time, you will have seen an over 10% drawback. If you held bonds, you are not affected because bonds will always pay the same interest.