This article is directed at options trading beginners and intermediate traders looking to take the next step into trading options.
Should You Trade Options?
Many traders need to be aware of the dangers of trading options. Options can be confusing, making it profitable for those who know how they work and unprofitable for those needing clarification. There is a reason why you have to apply via an application to trade options from your broker; it is perilous. In short, options are very profitable to the seller and at the other end, those who hold during options expirations end up at the losing end of the trade. It is a losing game for almost 90% of those who attempt options trading, especially for beginners. Asking the question, is option trading worth it? The answer will always almost always be NOOO!! However, if this warning is not enough to deter you, I will break everything down in the article below, and if those who are stubborn and still want to trade options I will provide safer ways to do it.
Is Trading Options Worth It?
Say you start trading options, and everything is going well, the truth is you can exponentially increase your profit trading them. This has happened before but it's a rare occurrence. People do get lucky. People can become millionaires overnight by trading them, but it's equivalent to winning the lottery. The truth is they will cause you to go broke if you don't manage things correctly; because that is how they are designed. They are severely leveraged trading instruments akin to replicating the casino.
Let's take the case of Apple ($AAPL) stock: say Apple moves 5% in a day and you decide to buy options in it. The problem is that the option is priced in a 5% move, and basically, when they sell you that option, it has that 5% movement embedded in the stock (this is a very simplified explanation). This is called volatility, meaning: if it does not continue to move at a fast pace, you will lose money buying that option. Here is the example: the day you bought it, it moved 5%; the remaining week it moved 1%. You will see a loss in the value of the option even though it went up 1% higher!
If you decide to trade options, the best strategies are: NEVER buy call options on a day when the stock moved significantly higher and NEVER buy put options when a stock moved significantly downward. Another example: say you bought Tesla ($TSLA) puts when it moved down 6%; the next day it is green around .3%. Your put did not lose .3% of the value; instead, the option lost 10%-20% (at least). Why? Because you paid for the 6% loss and the expectation that the next day the put will lose more. These are somewhat simplified examples, but this is what happens when trading options. Before deciding on trading stock options, you need to know much more than what you learn just by reading material like "Options for Dummies".
Trading Options on Earnings Announcements
Holding call options around Earnings Announcements is a losing game. You will find that most of your call-and-put option costs are priced into the earnings report of that stock. When you purchase a stock option, the volatility (potential movement) of a price is included in the put or call. If you buy option calls or puts before earnings on Tesla ($TSLA) and plan to hold it, the options and puts expect a 15% movement in price, so, therefore, your options get 15% more expensive (this example is simplified). However, when earnings come up and the stock only moves 3%, what happens to the cost of the options? It goes down! To be a winner, you would need Tesla ($TSLA) to jump more than 15% in this example. So just guessing if a stock goes up is not enough; it is how much it moved up that is important! One strategy options traders use is to buy stock options a few days before an earnings report and sell them before earnings. They make money because the options price has increased to an amount that is closer to the earnings report. It is called Trading Earnings Volatility. Again, this example shows that those who buy the options end up being on the losing end of the trade when holding through earnings.
Another issue is some stocks, for example, let's say at a certain strike of AMC ($AMC) has a very low volume of options trading. This is a red flag; this means it has a liquidity problem. It will be difficult to get rid of your options when you want to sell them even if the stock itself is quite popular. You are more than likely receiving an inferior price on these low-volume options. You will see the bid and ask prices are very wide; that indicates a market-maker trying to manipulate the price and make a profit off the low volume of options. Always stay away!!!
Always put limit orders when trying to purchase an option; the bid and ask prices are incredibly varied sometimes. If you don't know what you're doing, options trading will be a losing game for you; it should be strongly avoided unless you fully understand how stock options are priced.
Safer Way To Trade Options
By now you may have wondered if buying options is not profitable, what about selling? For those curious about that question, I have written an article exploring the various types of strategies to sell options including the pros and cons of each strategy.
For those wanting to learn more about options education, be sure to read up on the dangers of trading out-of-the-money options, which can be the most lucrative form of lottery tickets out there in the Markets, really made popular by Reddit's WallStreetBets. If you are interested in a more advanced understanding of options, especially ways to exploit them check out my more advanced article on What You Should Know About Options Pricing (which explains how many made millions off GameStop ($GME) using out-of-the-money options).
But keep in mind selling options also is pretty dangerous, especially when you are potentially margined. Keep in mind the articles listed above will give you a good understanding of the pros and cons of selling options. In reality, I despise options, as they are about luck unless you have some insider trading information that would make them worth it. But that would be illegal. Remember there really isn't a shortcut to becoming rich, I know many believe Option Trading is a shortcut to becoming rich but in reality, it's a fast way to go broke!