Do I need to learn how to trade options if I am going to trade the stock market? I plan on being a long term investor, not a day trader.
Explain to me the concept of trading options and how profitable it is.
Options are useful because they allow you to -
make a profit when share prices are falling
use leverage on a small account to control a larger value of stock
Options have some big disadvantages compared to simply buying stocks and holding -
no dividend payments for being long
expensive fees
leverage increases risk
complicated strategies are needed
liquidity in options is less than liquidity in underlying stock, so closing a position can be expensive and delayed
all options expire, so not truly comparable with long-term investing.
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Short answer is NO. And as a new trader I would not even bother to learn option trading as there are many stock traders who successfully trade shares without trading options.
To explain what an option is when you buy an option you buy the right but not the obligation to buy the underlining stock. So in affect you buy the option with the opportunity to convert that option to a full contract in the underlining stock at a later date.
However options have expiry dates and as such a limited life. The problem is that an option is divided into two parts that being part of the value of the option is for the stock itself and the other part is for the time value of the option. As an option loses time it loses value as well and when that option is nearing expiration the time value of that option decreases rapidly. About 80% of options expire worthless.
When trading options you also have the opportunity to either buy or sell options. If you are the buyer of an option you are the holder of the contract and your risk is limited. That is if you paid $500 for the option that is as much as you can lose on that trade. If you are the seller of the option you are the writer of the contract and you assume all risk on that option. Hence your risk is unlimited. That means if the trade goes against you you can lose a lot of money.
Just to add to the complexity of option trading there is a thing called Delta. This is the value of the option in relation to the underlining stock. That Delta varies but as a point of reference once you buy an option that option will normally only increase or decrease in value about 50% in comparison to the value of the underlining stock. So if the stock rises by $1 the option will only increase in value by .50 cents.
This is only the very basics of options trading and there is a lot more too it than what I have told you here.
Hope this helps
Cheers
Blackduck
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This question is quite controversial. Using options for trading stocks has both pros and cons so you need to understand clearly whether they would be useful in your particular situation.
When making such decision, you should consider the following key points:
- options provide you with a huge built-in leverage (something like with futures), but the downside risk is limited to the price paid for the option (if you are a newbie, never ever think about selling options).
- the first concept you need to become familiar with is a time decay: options loose their value each day, so may lose your money even if the price moves in favourable direction just because it moves too slowly.
- options give you tremendous flexibility, but you should be an experienced options trader to be able to benefit from all the opportunities they offer.
So, to my mind, options are very interesting and useful for professional traders, but before working with them you need to be experienced in trading stocks.
If you need to know about options go to the Option Clearing or Chicago Board of Options Exchange. They are the specialists and if you go through their webinars, etc. you can decide if it is right for you!
If you want to know the basics about Options there is a reference pamphlet called “A Guide To Investing With Options”. It is a PDF file which can be downloaded and covers the majority of things you would want to know. It is sponsored by The Options Industry Council. Let me know if this helps you out! Thanks!