Are Your Options Losing Value?
Today we'll be discussing the differences between investing with stocks and options. Let's first tackle the less complex investing vehicle, stocks. Most of the world already knows, but in case you don't, stocks are directional trading vehicles. If we are long the stock, then we make money when the prices of the asset rises, and we lose capital as the underlying asset drops in price. We can also sell a stock short in which the profit comes when the stock falls. In any case when investing with stocks, the direction is what matters. We don't need to worry about market volatility or time.
So we all know that stocks are simple, directional investments, but what about options? Well, trading options is actually trading 3 Dimensions...time, volatility and direction. I guess this makes options three times more complex than stocks. Now, let's look at a trading example to compare the difference. Look at this scenario:
What if Google moves up 25% in 2 years? Well, those stock owners would have just made 25% by holding on to their investment all that time. However, if an option trader held on to his Call options for 2 years, most likely there would be very little if any gain on the trade.
We know why the stock holder made money, but why would the option buyer lose money? Everyone thinks there is leverage in options, and it's true, but in this case, the leverage didn't work out for 2 reasons. One, the asset took too long to move, so the option time value decayed. Secondly, the asset moved up, causing its volatility level to fall, and this also helped the option price to move down.
So, hopefully you can see that in order to trade options, we really need to be educated. Entry level option traders usually buy Calls and Puts, and they don't understand why they lose money when the underlying asset goes the direction they are hoping. Remember, when trading options, you are not trading a single dimension; you are really trading a 3 dimensional asset. Finally, the exciting thing about options is that once you understand them, they allow you to be very flexible, creative and can be traded in any type of market. - 23196
So we all know that stocks are simple, directional investments, but what about options? Well, trading options is actually trading 3 Dimensions...time, volatility and direction. I guess this makes options three times more complex than stocks. Now, let's look at a trading example to compare the difference. Look at this scenario:
What if Google moves up 25% in 2 years? Well, those stock owners would have just made 25% by holding on to their investment all that time. However, if an option trader held on to his Call options for 2 years, most likely there would be very little if any gain on the trade.
We know why the stock holder made money, but why would the option buyer lose money? Everyone thinks there is leverage in options, and it's true, but in this case, the leverage didn't work out for 2 reasons. One, the asset took too long to move, so the option time value decayed. Secondly, the asset moved up, causing its volatility level to fall, and this also helped the option price to move down.
So, hopefully you can see that in order to trade options, we really need to be educated. Entry level option traders usually buy Calls and Puts, and they don't understand why they lose money when the underlying asset goes the direction they are hoping. Remember, when trading options, you are not trading a single dimension; you are really trading a 3 dimensional asset. Finally, the exciting thing about options is that once you understand them, they allow you to be very flexible, creative and can be traded in any type of market. - 23196
About the Author:
Are your current Option Strategies keeping you up at night? See why our motto is Max Safety, Max Reward trading options. Get your FREE Option Trading Video on Option Greeks by visiting us at www.SJOptions.com
posted by X - Men @ 1:10 AM
0 Comments
0 Comments:
Post a Comment
Subscribe to Post Comments [Atom]
<< Home