Another point of View

The successful use of options requires a willingness to learn what they are, how they work, and what risks are associated with particular options strategies.

Many option players blindly throw option strategies around without considering the health of the underlying equity using technical analysis.

First let's introduce you to some of the basic option definitions, including the advantages and disadvantages of trading them. Stock is an investment that represents part ownership of a company. An option is an agreement allowing an investor to buy or sell something, such as shares of stock, commodities or futures, during a specific time for a specific price.

A call option is a contract giving the buyer (also called "holder") the right, but not the obligation, to buy ("call away") the underlying stock from the seller (also called the "writer") at a specific price (“strike price”), but only for a specified amount of time ("expiry" refers to the expiration of the particular contract). A put option is a contract giving the buyer the right, but not the obligation, to sell ("put") the underlying stock to the seller at a specific price (“strike”), but only for a specified amount of time (“expiry”). There are many myths about the complexity and risk of trading them. Some are true, similar to trading any financial instrument without proper education, discipline and risk management. Let's explore some of them.

Advantages.: Stock options give traders more diverse choices of how to trade the underlying that are not available with trading stocks alone. To profit from trading stock, you must be right in the predicted movement (“up or down”). In trading options, there are strategies that let you profit if you are right in two out of three possible stock directions. For example, option sellers can profit even if the stock goes sideways. Buyers of options have a maximum loss equal to their cost basis, plus commissions. One option contract represents 100 shares of stock. The maximum loss to the equity player is also the cost basis, but that is typically more.

Option buyers are able to "control" the same number of shares of stock, but at a cheaper price, giving them higher levels of leverage and potential return on investment; however, this is also a double-edged sword that can harm traders if not properly managed. Additionally, buying put options often provides for more timely bearish strategies over equities, as they can buy a put if a stock is not shortable, and are also not subject to any up-tick requirements.

Disadvantages.: Because options are derivatives of the underlying instrument, traders MUST have an opinion of the direction of the stock, including the estimated speed of predicted movement, before even considering an option trade. Period! Then they must determine the best option strike price and expiration month to meet their expectations of the stock. Traders not understanding this starting premise are almost doomed for failure.

Additionally, because options are a fixed time investment, with time being the only constant in option pricing, both option buyers and sellers have to manage time closely. Some other disadvantages include: leverage can hurt; options often have bigger spreads or lighter volume than trading stock; volatility and time can hurt; many brokers do not allow all strategies; commissions can be larger; and you can lose despite being right about the direction of the stock, if time and “other” (Delta, Gamma, Theta...) are not managed correctly.