Have you been wondering if trading options is worth your time and effort after all? Would options trading payoff?
The answer is yes* with an asterix. Yes, option trading is worth it if strategies are selected carefully. Planning ahead for all possible scenarios and managing risk is the key to success in options trading. And the rewards are well worth the effort.
What is option trading and how it works?
Option trading is a bet. A time bound bet about the direction of the underlying [the thing that you are betting on]
You can bet on the movement of the underlying stock direction – up or down.
You can bet on the underlying not moving.
All the bets come with a time expiry.
The uniqueness of a derivative contract (options is one such derivative contract) is that it comes with a time limit.
Time can work against you OR work for you as we shall see in the below discussion.
You can be a buyer of an option or a seller.
The below table is a beginner’s quick reference guide on options:
Detailed article on call option here.
Are options better than stocks?
Yes, for the simple reason that options are leveraged products. An option contract size is typically of 100 shares – and the premium required to earn the ownership right is small as compared to the cash required for outright purchase of stocks. The premium required is almost 50-70% lower for options.
On the downside, there is time bound restriction for an option contract. Beyond this time, the contract becomes invalid. No such issue with stock purchases.
If you are able to manage your money actively – then options are the way to go.
Did you know that Warren Buffet sells options to take position on his favorite stock? Read about it here.
What are the advantages of options trading?
Leverage: as discussed above, for a fraction of the investment you can be holding a good amount of position.
Profit potential: if you are right, you are right by a huge margin. You get to make a lot of money. The premium of the option that you are long tends to shoot up if there were a spike in volatility and movement in your direction.
Additional Income: option trading can bring in additional income from your portfolio. If you happen to have a stock portfolio, you can use it to get portfolio margin and trade options. This way you get to make the best of both worlds. Portfolio gets to grow and you can rake in extra income from options trading.
Going into details about the advantages is beyond the scope of this article. You can refer to the recommendations below to enhance your knowledge on Options trading.
What are the risks associated with options trading?
Buyer: risk of losing premium paid
Seller: risk of losing capital to the extent of the UL move against you. Margin call. Additional capital requirement. Position being closed by broker for lack of margin.
Losing a significant portion of capital is one of the risks associated with options trading especially if you are an options seller.
Should you be a buyer or seller of options?
Be a Buyer of an option when you are 100% sure about the Underlying move and the TIME within which the movement will happen.
Buy naked option only when you know 3 things for sure: extent of the move, direction and time of the movement.
Be a Seller for all other occasions. Seller of an option enjoys many privileges:
– can be slightly wrong in predicting the underlying direction
– has time working in his/her favor
– can reduce potentially unlimited risk factor by being long a farther strike
– can make option selling into income generating strategy
– can buy stocks at a lower cost basis than outright cash purchase
– be the “casino house” rather than the gambler. House always wins
– make the best use of accumulated portfolio by using it as portfolio margin account
Can you trade options for a living?
Yes. Because of the advantages a seller enjoys (as stated above), option selling strategy can be used to generate steady income.
Options trading is well worth the effort. If you have invested your time and effort in learning about Options, you will be rewarded with a steady source of income, confidence to hedge your portfolio against any downturn, strategies to counter any movement in the market. Most of all, confidence in the market.
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