Why option is riskier than stock

Sometime the spread between the bid and ask can be great and sometimes it can be as small as a penny. It usually depends on the volume of the options being traded. Today I am going to work with Call options only. Specifically the buying side of call options. In another article we will visit the sell side of Call options and discuss the risky way and the most conservative way of doing them. Over 1 year the growth rate has been I went to my Charles Schwab account and purchased 2 Call Contracts on the stock.

I also used a expiration date of June 21, If they happen to expire in the money in other words should have been exercised and were not the Options Clearing Corporation and the Chicago Board of Options Exchange will randomly assign then or exercise them for you. These contracts allow me, in a way, to control shares of Apple Stock for a period of time. Now when it comes to options, TIME can certainly work against you. An option is like an Ice Cube. The day you buy it … it starts to melt.

If you have ever watched an ice cube melt you will notice that it melts slowly at first but the longer it is left out of the freezer the faster it melts. Take a look at the illustration below:. You must understand that this is the Time Value portion of the premium that was paid or received. There is generally two parts to an option premium … a Time Value and an Intrinsic Value. The intrinsic value changes based on the price of the underlying stock while the time value only decays over time.

But why, knowing that the time value of the option is only going to decay the longer I hold on to it? First notice that I purchased an option on August 7, that does not expire for about 10 months from that date it has a June expiration date.

This gives me plenty of time to let the stock work to increase my Intrinsic Value of the option. Now, you cannot always purchase options 10, 12 or 18 months out on all stocks though most larger companies allow it if they allow options at all , but I highly recommend it when you are buying. On the flip side, when you are selling options … then go short-term. I really like the time frame of 21 to 45 days. And, remember, not all companies allow options. Out of more than 10, publicly traded companies in America, only about 3, or so have options available.

If you are calculating that … it is a Return on Investment of Based on the Black-Scholes formula that calculates a fair theoretical market value for the option. For every dollar of movement in stock price, the price of the option can be expected to move by delta points. If the delta is 0. Deep out-of-the-money OTM options will have a delta which approximates 0.

Deep in-the-money ITM options will have a delta which approximates 1. At-the-money ATM options have delta near 0. Second I also consider this. The winners should more than make up for the losers. If buying … make sure expiration is 6 months or longer away until you really learn what you are doing. The longer the term the higher the premium … but it gives time a chance to work in your favor.

Set a profit target and stick with it. Its been proven time and time again that taking smaller profits more quickly will make you more in the long run because you can trade more. That's the biggest mistakes most make in option trading. Short selling is selling in advanced stocks that you do not own. What this exposes the trader to is an unlimited amount of loss should the stock rally all of a sudden, running the short seller into margin problems.

In option trading, you could simply buy put options to profit from the same drop but yet limiting losses to only the price of the put options!

In option trading, there are option strategies which profits from BOTH up or down moves, up or stagnant moves, down or stagnant moves and even when the stock remains totally stagnant! The more directions you can profit from, the higher the probability of win and therefore the lower the risk. The most popular strategy in option trading to profit from both an up and down move is a Long Straddle.

Why Stocks Riskier Than Options : No Hedge Hedging is the practise of reducing risk by taking one market position to offset the risk in another. In stock trading, the only way to hedge your position against risk is to manage and diversify your portfolio. In option trading, you not only can manage and diversify your portfolio, you can also hedge options with options and even hedge stocks with options!

Read about How To Hedge Now. The most popular strategy in option trading used to hedge stocks is a Long Put Option. Why Stocks Riskier Than Options : Conclusion As you can see, stock options, being a more advanced financial instrument than stocks itself has a lot more safety possbilities in it, making option trading safer than simply trading stocks. However, anything good can be abused and abusing the leverage effects of stock options has led to the popular myth that option trading is extremely risky.

Just as crossing streets can be life threatening if one don't obey traffic rules, option trading can be extremely dangerous if one don't obey the rules of leverage. However, when leverage is respected and used properly, option trading can indeed be a lot safer than stocks.

Important Disclaimer : Options involve risk and are not suitable for all investors. Data and information is provided for informational purposes only, and is not intended for trading purposes. Neither optiontradingpedia.