Earlier, we introduced the three uses of options—generate income, speculate, and hedge. Now, let's explore these three approaches in more detail to help you understand how each works.

First, options can be used to attempt to generate income and potentially enhance returns. With these strategies, you take on the role of an option seller. Option sellers take on obligations and more risk, and for this, they're rewarded with the options premium. Typically, the goal is to sell options that eventually expire worthless. To option sellers, a worthless option is a great outcome because it allows them to collect premium and avoid their obligations tied to the contract. However, if things don't go their way, they'd likely incur a loss and may be forced to buy or sell the underlying stock position.

When constructed in certain ways, income strategies can be high-probability trades. This means the odds that the trade will be profitable may be in the seller's favor. Not including any changes in the underlying stock, an income strategy is typically profitable when the option loses enough value that it can be bought back at a lower price, or it expires worthless. Bear in mind that a high probability of success typically means potential returns are low for any winning trades. It's also important to note that high probability doesn't mean low risk. A few income strategies have high potential maximum risk because they're tied to owning a stock. While unlikely, the worst possible outcome of owning a stock is the stock falling to zero. And strategies where you don't own the underlying shares are among the riskiest options strategies out there, as you'll learn later in this course.

Options can also be used to speculate on a security's future price movement. Speculative trades often take on greater risk with the hopes of greater potential returns, and they tend to be based more on price movement than any fundamental value in the underlying. There are a variety of ways to speculate with options. For example, you can place a low-probability trade with the potential for significant returns or construct a trade with a probability of success similar to buying and selling stock.

Speculation is generally high-risk trading focused on short-term price changes. Speculative strategies, which often have a lower probability of success, are intended for active traders—those who have not just the risk tolerance but also the time to learn strategies and manage trades, as well as the financial resources and personality to bear with the market's ups and downs.

Finally, options can also be used to hedge a position or portfolio. A hedge is a protective strategy designed to offset risk or loss in a portfolio. The trader agrees to pay a relatively small amount in return for a measure of protection for a limited period of time if things go wrong.

With a hedging strategy, you attempt to reduce a certain level of your risk and transfer it to someone else. Say, for example, you hold a stock, but you're concerned about the outlook over the next three to six months. Rather than sell the shares, you could potentially buy a certain type of option that helps hedge your stock position.

If the stock keeps going up, the amount you paid for the option will offset some of your gains. But the amount you pay for the option is typically much smaller than the amount it could protect if the stock were to fall without a hedge. And if the stock does fall, the option will likely increase in value and offset some of the losses on the stock position.

Unlike income strategies, hedging strategies are usually low-probability trades in the sense that they aren't designed to be profitable by themselves. Rather than attempting to profit from changes in the value of the option, the goal of hedging is to offset perceived risk. After all, the preferred outcome is for a hedge to be unnecessary. Losing money on the hedge or having it expire worthless means you probably made (or at least didn't lose) money on the stock position you were trying to protect. While hedging strategies aren't covered in this course, consider researching "protective puts" if you're interested in learning more about hedging strategies.

Each purpose—generating income, speculating, and hedging—could play a role in your overall options approach and in your portfolio. That's the thing about options: There's a lot you can do with them.