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When Should Investors Buy Options?

One way investors can get themselves into trouble is by buying options -- namely, puts and calls, which give you the right to respectively sell or buy a specific stock at a set price in the future. There's a time and place for using instruments like these in the course of your investing, but it's important to know these boundaries.

In the latest episode of Industry Focus: Financials, analyst John Maxfield and host Gaby Lapera address this, sharing a few tangible pieces of advice for investors thinking about buying options.

A full transcript follows the video.

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Gaby Lapera: I think people who trade options really need to know what they're doing. You can't just do it to do it.

John Maxfield: I agree.

Lapera: You really can't, because then you get this guy I've mentioned multiple times on the show who shorted Valeant, and the price went way up and suddenly he was $300,000 in debt. That's more of an error of not understanding how options work. But, you really want to have some kind of solid thesis for why you're putting a put in, not just doing it just to do it.

Maxfield: Yeah. The way I think about it is, my father told me this going way back, whenever you make any type of speculative investment, and when you're buying options, it's a speculative investment, because there's no inherent value in those options that will last beyond the expiration date. When you're doing something like that, you just have to assume that it goes to zero. That's not what your hope is, but you certainly shouldn't be doing these things unless you have a good sense for how investing works, and even if you do have a pretty good sense for how investing should work, you certainly shouldn't be doing these types of things with money that you would ever need. The purpose of this type of thing is a small, pinpointed bet that is either straight up directional or for the purpose of hedging other holdings in your portfolio.

Lapera: Yeah. I 100% agree. It's the same concept as, don't lend money to someone that you need, or that you ever expect to see again. Don't do that for options, either. At least in my opinion, and probably Maxfield's.

Gaby Lapera has no position in any stocks mentioned. John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool has a disclosure policy.