I often associate the investor education space with the business of health and fitness.
There are so many gimmicks and fads… that take advantage of those poor uniformed souls just trying to make their lives better. The only thing that really bugs me… is when I read articles or see talking heads say that options are a fool’s game.
Sure, options investing isn’t for everyone…however, if you’re investing in stocks…and you’re not using stock options to express your market sentiment…you’re doing something wrong. The chances of a stock going up or down are 50/50.
However, with options you can structure trades that skew the probability more in your favor.
In most cases, using options instead of buying stocks outright is a better deal…not to mention the ability to change the odds at your court.
Why?
First, options are leveraged instruments.
That means you need less capital to get started. For example, a stock option contract gives you 100 shares. Let’s say AMNZ is trading at $337.49 per share (hypothetical situation).
For $33,749 you could buy 100 shares (not including commissions and fees). On the other hand, you could buy a call option…controlling the same number of shares for much less.
Let’s say you had a bullish bias and bought a SEP $320 call option for $2900 (expiring in 76 days). In very simple terms, this SEP $320 call will earn $67 for every dollar the share price rises.
If you owned all 100 shares… your PnL would be $100 higher for every higher dollar the stock price moved.
However, look at how much more capital it takes to buy the shares… more than 11 times the amount of money.
In fact, if the stock investor bought 10 shares for $3374.90… he would only earn $10 for every dollar the stock price went up… options upside.
Options give you the opportunity to diversify your stock portfolio.
In the example above, an investor would have to shell out nearly $34,000 for 100 AMNZ shares.
If they had a small trading account… it would be very difficult for them to diversify due to the huge capital absorbed by the cost of buying shares.
An investor with a $25,000 portfolio can do a LOT more with options in terms of diversification and profit potential (from leverage). Using stocks instead of options is a misuse of capital… and hurts the small investor who wants to have a balanced and diversified portfolio.
In addition, call options and structured option trades define and limit risk.
For example, when you buy a stock… your risk is limited to your initial investment. In this case, the risk is $33,749.
Of course, the probability of AMNZ going to zero is highly unlikely.
However, if you’ve lived through the dot-com bubble and the most recent financial crisis… you’ll know that anything is possible. With the SEP $320 call option… the total risk on the trade is $2900.
Not only that, but the long call option enjoys the same benefits as the long stock position, namely indefinite earnings potential.
A more realistic fear than AMNZ going to zero is a mini-flash crash. Schedule and high frequency trading play a big role in the US stock market. One only has to look at the funky events at Anadarko Petroleum Corporation (APC) last year to see how powerful they are.
“On May 17, 2013, in the last seconds of trading, shares of Anadarko Petroleum Corporation (symbol APC, $45 billion market cap) traded from $90 to $0.01 in 45 milliseconds. Oops. This can be a record: lose $1 Billion per millisecond. That’s a rate of $1 trillion per second. Now this is something Congress will be able to understand. Maybe NYSE should have kept their LRP breakers after all?
Now, if you’re a long-term investor, chances are none of this will really affect how you invest. However, it could be if you’re a responsible trader… who has caps in place to limit losses.
How upset would you be if there was a sudden little drop in the stock you’re in…and you stopped…only to see the stock bounce back? This is a very real concern.
Of course, in the case of APC…a lot of those low priced prints were broken…but I’ve heard horror stories from dealers who have lost real money from these mini-flash crashes. It’s much more relaxing… to be in an option position… where you have defined and limited risk.
But the options are not too complicated…
With options, you can express your opinion about the market in many different ways.
For example, there is a strategy when you think a stock will go flat… not only that, but you can be very precise… especially on the magnitude of the stock’s price move: a little higher to a lot higher , slightly lower to much lower.
As you move on and get more comfortable with options… there are strategies that express a range bound move… and even non-directional strategies that focus on your views on volatility.
Heck… there are times when I took a profit on a position even though I was totally wrong in my assumption.
I would have lost money if I owned the underlying but because I used options and structured trading which gave me the opportunity to make money even if I was wrong.
Options give you the flexibility to be positioned for all market conditions
Stocks can go up, down or trade sideways. However, if you buy a stock, you can only make money if the price of the stock goes up. On the other hand, if you are short stocks, you can only make money if the stock price goes down. If the stock trades sideways… you don’t make any money.
With options, you can also take advantage of those situations.
The possibilities are truly limitless. But the key is not to be afraid to invest in options. Sure, if you’re reckless and irresponsible… you can lose money quickly.
That should go without saying…but if you learn the right approach…and build a foundation…options investing will trump stock investing most of the time.
Let’s face it, the people who discourage you from options are the ones who don’t fully understand them. And believe me, if you don’t have the time or patience to understand the options… you should probably stay away.
Investing in stocks is like driving a Ford Pinto…it will take you from point A to B…and you’ll have no problem giving it to your 16-year-old son when he’s practicing for his driving test.
Option Investing is like a Ferrari GTE Spider…a powerful and sophisticated multi-geared machine…something you wouldn’t dare let your 16-year-old son take for a spin around the block.
Are you a stock investor looking to take the plunge into options?
If so, I’d love to hear your reservations about why you haven’t taken the plunge.
Also, if you’re new to options, I’d like to know how you’ve been doing so far… what’s been your biggest hurdle so far?