When used correctly, options significantly enhance investment performance. Options trading does, however, require some education.
Is option trading worth it given the complexities?
Options can be an excellent investment vehicle to capitalize on short-term price movements making them a worthwhile strategy. Advanced options trading combines the leverage benefit that options provide with the ability to hedge, providing smart traders a way to increase return probability while managing risk.
If you’re new to options trading, be aware of a few challenges.
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What are the Drawbacks of Options Trading?
Before jumping in, consider these disadvantages to options trading:
While several U.S. brokerages offer zero-commission trading – like Charles Schwab, TD Ameritrade and Robinhood – investors outside of the United States incur fees to buy and sell options. Over time, the excess costs can hinder portfolio performance.
Remember, options have finite lives. If your investment thesis doesn’t materialize by the time the option expires, it’s worthless. Bottom line? Choose an asset. Identify a catalyst. And make sure it can hit that target before the option expires. In other words, don’t fall victim to this as explained in my post Do Options Lose Value Over the Weekend.
Delta. Gamma. Vega. Theta. Rho. Pay attention to the ‘Greeks,’ because they determine performance. Volatility (Vega) has the greatest effect. Even if the underlying asset moves in your forecasted direction, the value of the option can be offset (or outright decline) if there is a significant drop in volatility. These are some of the most important elements of a good options education.
Keep in mind though, the option price will always equal the exercise value at expiration.
What are the Benefits of Options Trading?
Reasons why option trading is worth it:
When buying options, your downside is defined: you can’t lose any more than your initial investment. With calls, your upside is unlimited and with puts, it’s usually north of 90%. Because of this, you can commit a small amount of capital and still maintain all of the upside of actually owning the underlying asset as explained in my post Pros and Cons of Option Trading.
Efficient Use of Leverage
Remember, option trading is a leveraged play on the underlying stock or ETF. If a stock is trading at $100 and an at-the-money (ATM) call option costs $2 – you can replicate a $10,000 equity position by purchasing $200 worth of options. The position is leveraged at 50:1, and if the stock increases by $1 (1%) – holding all else constant – your option position will increase by 50%.
Have a look at the table below:
Using options is a great way to enhance portfolio performance. Because your downside is limited (when buying options), you can speculate on the movement of a particular asset without committing too much capital.
Over time, most option traders aim for a success rate of greater than 50%. However, because purchasing options has a positive skew – where you’ll lose a small sum of money most of the time, but make a large sum of money when your bets pay off – the gains on winners can easily offset the losses on the losers.
So is option trading worth it?
Well, it really comes down to whether you want to learn how to trade options. Options are a great way to capitalize on short-term price movements and can also hedge your portfolio if and when volatility spikes.
If you’re just starting out, it’s probably best to paper trade options. Most of all, remember, purchasing options instead of selling options allows you to control the downside.
And once you become more confident, then consider approaching from the sell-side and adding spreads to manage risk as taught in our courses here at Power Cycle Trading.