Ditch Options And Buy Stocks With “Cheap Optionality” Instead

It probably didn’t take long after becoming a trader to stumble upon options. Brokerages and websites all over the internet are constantly pitching these complex financial derivatives, claiming things like “defined risk” and “100% returns a month”. But these advertisements only end up luring novices into a game that creates losses rather than stunning returns.

Newer traders aren’t wrong for putting themselves into situations where they can risk a little to make a lot. Buying an option comes with capped risk and unlimited reward. But achieving the skewed risk/reward profile in the options market comes at a cost that can drastically erode returns.

Buyers of options suffer from something called time decay or “theta.” Theta is like a tax that option buyers pay to option sellers in return for the serious risk those sellers take. (Selling options results in limited earning potential with unlimited loss potential.)

This erosion of option value from theta complicates the game. Not only do you need to correctly determine the direction of the underlying stock, but you’re forced to time it perfectly too. If you buy 30 day calls and the stock doesn’t move in that time, you’re out of luck and end up with a 100% loss.

On top of this timing component, option traders also need to understand volatility. Every time you take an option position you’re speculating on two things, the direction of the underlying AND its volatility — specifically, its implied volatility (IV).

IV is the option market’s best guess at how fast and far a stock can travel before the option expires. IV is always priced into the contract and has a large effect on the final profitability of the position. Buyers of options benefit from outsized moves (more volatility) and sellers of options benefit from sideways chop (less volatility).

So to win as an options buyer, not only do you have to correctly predict the direction the stock will travel, but you have to pinpoint the time period in which it will make the move, and make sure you aren’t overpaying from a volatility perspective.

1 2 3
View single page >> |

Disclaimer: If you want to know how our team at Macro Ops hones our trading machine with Soros’ teachings, click here.

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.