I chose today's image to highlight a choice we've all faced: you want to invest in a given sector, but you can't figure out yet which companies within that sector will pull ahead as the real leaders. It can be dauntingly expensive to invest in all of them, but what if you choose the wrong one? Enter the second use of index options: as a means of speculating on an entire sector, without having to pick the exact-right company within that sector to do so -- something called "selection risk".

Speculate on an entire sector -- with less selection risk.

Are you fascinated by oil, or startups, or the technology sector -- but not sure how to pick the real leader of the pack? With more specialized index options, you can speculate on all the major players in a given sector -- eliminating the guessing game as to which stock will do best.

Consider energy for a minute. If you feel strongly that energy demands will continue to rise, taking prices upward, you could search for the leader in that sector or sprinkle your investments around the top three. Or, you can check out OIH options (Oil Services HoldersTM Trust) and make a single bet on a wider swath of the entire sector.

Sector-oriented options come in many flavors -- see this CBOE list for more information. Index- and ETF-based options make it convenient to trade an entire sector, even a basket of stocks from a given country or region. Historically they're also a bit more stable than picking individual stocks. It takes only one or two bad news stories to upset an individual stock; indices don't make precipitous swings as often.

Then again, any strategic move carries with it risks -- even if it minimizes risk in other areas. Say you purchased OIH for the reasons described above. Sure, you may've reduced the risk of choosing the wrong company in the energy sector (aka selection risk), but you now have to keep an eye on other risks, like energy sector fluctuations, rises in alterative energy, and the like. Unfortunately, no move can reduce your risk to zero.

Hope you enjoyed this series on index options. If you have any questions or comments, I'm always eager to respond. Meanwhile, here's hoping spring has finally arrived where you live!

Regards,

Brian (OG)

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.