Anyone with a brokerage account, 401K or IRA is most likely familiar with stocks, bonds, mutual funds and Exchange Traded Funds (ETFs), and they have most likely heard about options as well, but are not familiar with them. In fact, they probably have adopted the prevailing view that options are risky and should be avoided.
But, the truth is, with the proper education, understanding the ins and outs of options is fairly simple and trading options properly can actually be less risky than investing in or trading stocks.
Depending on your investment or trading goals, there are a variety of options strategies available, from the very basic to the more complex. But even the more complex strategies become very easy to apply with a little practice.
The analogy I always use with my students is that learning to drive a car seemed very complex at the time, especially those left hand turns. But, in no time, driving in almost any conditions became second nature, no problem at all.
Some strategies allow you to profit from the directional movement of a stock, for example, without actually buying the stock, all with much less risk than had you bought the stock directly.
Other strategies allow you to protect your portfolio from the next market crash; it’s like buying insurance on your portfolio. Yet other strategies allow you to collect “income” on a regular basis.
Now this is not to say that trading options is not risky, but investing in or trading stocks, bonds, ETFs and mutual funds is also risky. Because of the high degree of leverage that options offer, trading options without the proper education is, indeed, extremely risky, like driving a car with no training. However, with the proper education, trading options can actually be less risky than trading stocks.
This is why brokers and others always caution you about options with words like: “Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with risk capital.” They know that without the proper education trading options is indeed very risky. And that is why most people completely miss out on the many advantages and profit potential of trading options. They never bother to get educated.
So, at a minimum, you owe it to yourself to get educated and then, from a position of strength, decide if options trading is for you. In so doing, you will become aware of a whole new world of profit potential and risk management that the best investors and traders in the world apply routinely.
Our objective in this report is to pull back the curtain and remove the mystery surrounding the world of options. We’ll cover options basics in a way that will be completely understandable including the “Greeks” and other options jargon. This report will not make you an expert, but it will open the door for you and motivate you to take the next step to more advanced education on each of the options strategies available.
Options Basics & Overview
Options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying stock at a specified strike price on or before a specified date. The seller incurs a corresponding obligation to fulfill the transaction, which means that they must buy or sell the underlying stock if the owner elects to exercise the option, prior to the options expiration date. The buyer pays a premium to the seller for this right.
Options that give the buyer the right to buy a stock at a given price are called "calls" and options that give the buyer the right to sell a stock at a given price are called "puts". Both calls and puts are commonly traded.
To trade options you need to open what’s called a “margin account” with a broker. And while it is true that you must be a little more financially able to open up such an account (usually a $5,000 minimum), there are many options strategies that are very low risk. Some are simple, some are relatively complex, and some options strategies are used to provide income on an ongoing basis.
Options provide very high leverage and, as long as you do not abuse that leverage, trading options properly can be less risky than trading the underlying securities directly.
To understand the basics of options, I will cover definitions, option types, options vs. stocks, options language, and then how to handle the unlikely event of assignment.
Options provide the trader or investor the opportunity to manage risk in the markets in ways not available when just buying a stock or ETF; and, as we get into this, you will see how different strategies can accomplish just that.
Options are risky? Well, they are no more risky than trading the underlying security. If done properly, options trading can actually be less risky than stock trading.
Yes, if you abuse the leverage aspects of options and put options sizes on that are too large, relative to your account size, you are going to have a problem. And it is precisely the leverage aspect of options that, when abused, causes them to be highly risky. But, like anything, if you know what you are doing, there is no need for that.
An example would be a driving analogy. If you put a kid in behind a steering wheel, driving, or attempting to drive a car down the highway, would that be risky? Boy, you bet
it would be! But if you put an adult behind the wheel, who has had proper driver’s training and is properly licensed, the risk is dramatically diminished. Options is the same way, if you know what you are doing, they are no more risky than trading stocks and, indeed, can even be less risky.
Options require far less margin than buying stocks or ETFs outright. When you buy a stock or an ETF, you are going to have to put up the full amount of money; or, if you have a margin account, approximately half or 40% of the money. But, with options, it is significantly less than that. Oftentimes, 10% or 5% of the margin is required to control the same number of shares. Again, if you abuse that and overtrade, or put position sizes on that are far too large, relative to your account size, that is when you get into trouble, and there is no need for that.
The profit potential trading options can be far greater than trading stocks or ETFs. Successful options trading does require good methods to evaluate the price movements of their underlying securities. Then, given the assessment of the underlying security, you can apply the proper options strategy.
So there are two parts to this:
So you need both of those. But, if you are trading stocks, you need that anyway. You are not just going to go in and put orders in blindly; you are going to go in and trade according to what your assessment is of the market or likely market direction.