Probably the most common reason people get involved with options is because of the leverage options afford to the retail trader. We've all heard the stories of huge leveraged profits - 100%, 500% 1000%. It is true that these gains are possible on long option strategies, but the reality is a bit more complicated than the big wins. Leverage as we should know, is a double edged sword. Often it is this leverage that prompts people to select inappropriate strategies for their account and risk profile.
If you have started trading options or considering trading options for this reason alone, I suggest it is a very bad reason for doing so because of the nuances of option pricing. You can of course use options for the massive leverage they offer and a few people will “get rich quick”. That is the law of large numbers. But most traders attracted by gargantuan gains and willing to take on the risk, will “get poor quick”, but you don't often get to hear about those. Like any gambler, they only tell you about the wins.
This is not to criticize options trading at all, but there are a number of "good" reasons to trade options.
Let’s look at some good reasons why you should trade them:
* To speculate on the direction of stock with limited risk.
* The hedge a stock or portfolio.
* To reduce capital usage.
* To make extra income from long term stock holdings
* To set buy levels in the market while collecting premium.
* To take advantage of large moves in the market, no matter which way.
* To profit from range-bound stocks.
* To construct specific risk/reward profiles that suit your forward view, even if that view is unclear.
* And yes, leverage, if intelligently applied and providing risk is controlled.
The reason is flexibility. You can create a multitude of risk/reward profiles, rather that “if it goes up you win, if it goes down you lose”. You can use ALL the strategies according to the varying situations you’re faced with, you can use a select few, or you can choose one single strategy and look for opportunities to suit.
I recommend being conversant and proficient with as many strategies as possible, because market conditions can change very quickly and one type of strategy may no longer be suitable for the new conditions.
There are of course, risks in trading options, just like any endeavor where there is reward, and I’ll be comprehensively detailing those risks as we get into the meat of the course.
It is a sad fact that many option traders quit the game after sustaining a few losses where they did not understand the reason for the loss. If I could achieve one thing with this course, it would be to help traders understand exactly where their risks are.
I’ll have a quick word about risk in the next section, before we start into the main course.
Next - A Quick Word On Risk