Stock Options as Tools

Stock Options as Tools

There are people that believe stock options are dangerous, risky, and are to be avoided in place of safer shares of stock. They know it is possible to lose your entire account trading options. If you are selling options short then it is even possible to lose more than your account is worth if you use enough leverage and have a trend move against one of your short options far enough. Then others believe options are a pathway to incredible wealth  and can put you on the fast track to being a millionaire if used properly. Options do present the opportunity to make much larger returns on capital at risk than stocks do. Through controlling large blocks of stock through option contract leverage you can return 20% on your capital at risk when positioned right with the market direction. I have traders in my twitter group that have returned 100% to 1000% on their out-of-the money option trades. So it is possible but option traders must understand that it is your position size and your system’s winning percentage that will determine your profitability as an option trader more than any one trade.

Option profits can leave you as fast as they come in if risk is not managed closely to keep those profits. I know of amateur traders who have done very good with options by simply using them in place of stock in a controlled matter. I have also seen professionals completely reject them due to the added layer of complexity they add with their pricing model. With options you have to be positioned correctly for both the price direction and the magnitude of the move inside the timeframe of your options expiration date to be profitable. Options are more difficult than stocks because you have limited time to be right. You must be able to lock in profits with the right timing to both maximize the gain and take the money off the table while it is still there.

Who is right? Are options good or bad? They both are. If you do not know how to use options correctly in your trading you can not only blow out your account but with short options end up owing more than your account is worth, this is true. I have seen it happen many times. Both amateurs and professionals have lost everything and left in debt to their brokers through having highly exposed risk with short options. Selling options are not good or bad in themselves it is the position size and risk exposure that will make or break and option writer. Selling options provide a trader with the ability to act as a casino selling bets that have terrible odds of winning which can create a great winning percentage for the option seller. I highly recommend not selling naked short options but credit spreads so the loss is always hedged from disaster and the potential loss can be quantified instead of open ended. Selling options can create a great winning percentage for the seller and be profitable. Most option writers prefer to sell options when they are most expensive when the VIX is high and option premium is the highest due to the risk.

 If you do your homework, options are incredible tools for amplifying your returns on your capital at risk while allowing you to both apply leverage in your trading and at the same time with less risk. How is this possible? Long options are contracts with a limited down side and unlimited up side. Options are tools for transferring risk to another trader for a price. Understanding the odds of each bet is the key. Whether you are on the long or short side of option contracts you want the odds to be in your favor for profitability. You want to never risk more than 1% of your total capital on an option trade regardless of your beliefs about the trade. Options can go to zero by expiration and they can also go up 1000%. Trade them with this understanding firmly established in your mind. As an option trader you want to have big wins, small wins, or small losses. Eliminate the possibility of large losses from your process and you greatly increase your odds of long term profitability.  

Stock options are for..

  1. …managing risk through controlling shares with less capital.
  2. …putting the odds in your favor.
  3. …making bets on volatility or a price inside a specific time frame.
  4. …insuring a longer term stock holding from major losses.
  5. …replacement of margin.

Stock options are not for…

    1. …gambling.
    2. …going all in on one trade.
    3. …being used if you do not understand them completely.
    4. …selling and taking on unmanageable risks.
    5. …trading with the odds against you.

Options are trading vehicles like any other. They require a trading system, the right mindset, and risk management. They are simply tools for trading they are not a quick and easy path to get rich quick.  This asset class does present amazing opportunities for capital growth and returns if used properly. This book will be exploring how to use options in your own trading.