Option Funds

Option funds are mutual funds that invest in stock options as opposed to actually purchasing stocks. Stock options allow you to purchase or sell a set amount of shares of a stock at a set price for a set time period. The option to purchase stock at a specific price is known as a call. The option to sell stock at a specific price is known as a put.

When you purchase a call option, if the price of the stock goes up in the specified time period, you can exercise your options and buy the stock at the lower option price, then turn around and sell the stock immediately at a higher price. If you buy a put option, you're betting that the price of the stock will go down during the specified time period, and your option allows you to sell the stock at a price higher than the present one (which is going down).

Investing in option funds is definitely on the riskier side of mutual fund investing. Why are stock option funds such risky investment vehicles? It's very difficult, even for investment professionals whose job it is to predict the twists and turns of stocks and the market (or at least try), to time options right so as to profit from investing in them.

A variation on basic option funds are funds that actually purchase stocks and then issue options on the stocks they purchased. This type of option fund can produce dividends for investors because of the options being sold, but doesn't rate highly as far as growth goes, because the options are exercised if the price of the stock purchased goes up.