Basic Understanding Of Option Trading

There is a general misconception in the trading community that trading an option is too risky. Options can be risky, but they should not be. Depending on your risk tolerance, the options may be low-risk or high-risk. They can be used for speculation, but also for hedging, security, leverage, etc. There is more than one way to make money with options. Here are some common myths and misconceptions about option trading.

Making money with options is easy

I promise you to earn money without any hard work while recovering thousands of this process. They present some of the highest risk strategies (such as weekly option trading) as “little or no risk”.

The truth is that learning to trade and invest successfully requires a lifetime of work, dedication and focus. Not only is there a long and difficult learning curve to learn the basic fundamentals, but you will soon realize that being a student of the markets never ends. To become an engineer you have to study 4 years, and maybe 4 years (at least) to become a good one. Why do people expect to be different in trading?

The only profitable way of trading options is buying calls or puts?

This is a very common misconception. While it is true that buying a call or a put can be very profitable, it is also a more risky way to trade. When you buy a call or put, you have to be correct three thinks:

  • Speed ​​direction
  • Size of speed
  • Speed ​​time limit

The underlying has to move in the right direction, and fast. You can correctly guess the direction and size of the move, but if the move occurs after the option is over, you lose money. Even if everything works in your favor, the inherent volatility can still make you lose money.

Options are for speculation only

The truth is that options can be used in many ways. They can be used for speculation, but also for hedging, security, insurance policies, income, etc. for example:

An investor who is a stock, but is concerned about short-term volatility, may purchase a protective put to hedge his investment.

The investor who believes that the market is trading in a range can trade the category of income that the strategy produces, such as iron conductors, calendars, etc.

Investor who wants to buy stock at a discount can use the naked put strategy.

Selling naked options is too risky

Did you know that selling naked put has the same P / L profile as selling cover calls? Yet most brokers allow trade to sell covered calls to their IRA accounts, but not naked puts? I find it very ignorant. An alarming number of financial professionals, including stockbrokers, financial planners and journalists, are in a position to educate the public about the many benefits that accrue from adopting nude put writing (and other alternative strategies), but fail to do so . Many public investors never bother attempting to learn about options after hearing negative statements from professional advisors.

Writing a naked put option is a much more conservative strategy and certainly less risky than simply buying and owning stocks. As such it should be considered by millions of investors as an attractive investment option.

90% of options become worthless

According to The Chicago Board Options Exchange (CBOE), here are the facts:

About 10% of the options are exercised (the trader takes advantage of his right to buy or sell stocks).

Almost 55% -60% of the options are closed before expiration.

And about 30% -35% of options end up worthless.

The CBOE goes on to point out that an option does not say anything about the benefit of the expiration worthless strategy that it may be part of. Multi-legged strategies may often require that one leg or more may end up useless, although the strategy as a whole is profitable.

Only option sellers make money?

The truth is that both option buyers and sellers can profit from option trading. If only the sellers made money. There will be no buyer. There will be no market since there is no buyer. While sales options have an edge in many respects, it also exposes you to negative gamma.

As Mark Wolfinger wrote: “Buying premium is a road less traveled, but it can be profitable for a well-groomed, disciplined trader. This does not mean that it is better or worse than premium sales. It just means that there is more than one road to Rome. “

Trading Options is a zero-sum game

The truth is that options can be used as insurance policies. They can be used as a risk management tool, not just commercial vehicles.

As Mark Wolfinger explains: “If I buy a call option and make a profit by selling at a higher price, there is no reason to believe that the seller took the loss in line with my profit. The seller may have hedged the play and I made even more profit from it. I don’t see anything similar to a zero-sum game in hedge option options. I understand that others see it as black and white: if one was gained, the other was lost. But this is an oversight. “

There is more than one way to trade options. Position size is one of the most important elements of trading, specifically option trading. Some smaller winners achieved with less risk may be better that a larger winner achieved with higher risk. Selling naked options may actually be safer than trading stocks.

What’s really important is not an occasional 500% winner, but an overall business plan. The key to success in option trading is using a mix of trading options of various options, such as straddles, calendars, iron conductors, etc. In my opinion, you can succeed in trading some of the options, which you can “expect” by buying some of the money options cheap.


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