You’ve spent the last several months with me perfecting the craft of trading options.
And along the way, people may have warned you to stop what you’re doing immediately… or better yet, to not even start.
Now to be fair, many of the people who have told – or will tell – you the dire reasons to stay away from options are likely those who are closest you… your significant other, parents, grandparents, broker, financial advisor, or a combination of these.
And when telling you their strong beliefs, they honestly think they are looking out for your best interest. They want you to be safe and smart.
They may even know or have heard of someone who lost everything because of options trading, and they do not want to see you become that person.
I’ve heard these horror stories too… and from loved ones that ultimately wanted to protect me.
I respect anyone in your life who is saying to you what they believe is in your best interest, even if they themselves haven’t personally experienced the risks of which they warn you.
But I am an options trader-and have been for over 25 years.
Throughout my trading career, I’ve experienced the first-hand trials and tribulations that helped me separate the facts from the fables about options.
I’ve made it my mission to educate anyone who wants to learn how to do what I do best.
And I do this by removing the fear of options and giving the real expectations of becoming a wealthy options trader.
So let’s put to bed the top seven myths about options…
Myth #1. You need to be a professional trader to trade options
Debunked: In today’s trading environment, options are more widely-accepted than ever before, and trading options is more like trading stocks than it was even five years ago-even if just as a small percentage of traders’ portfolios. Even better, there is a great deal of options education going on, including my educational company, that helps people gain the understanding (that is otherwise discouraged by institutions) behind trading options.
Myth #2. Options will always be too difficult to understand
Debunked: The concept is actually easy to understand in the sense that there are only two types of options: calls and puts. There are only two things you can do with them: buy them or sell them.
You use the type of option based on whether you feel the stock will trend higher or lower or will stay in a sideways range.
The complexity comes with the various things you can do with the options in a trade where you have one trade that is both buying and selling options at different expirations and prices. You can get as fancy as you want with the more education you gain, but keeping it simple is the best place to start. As you become more experienced and more familiar with options, you will start seeing the patterns that exist in the trading world.
Myth #3. Options are too risky and you can lose ALL of your money
Debunked: The fact is, options were originally created to help mitigate risk. And they are still used today for that purpose. Options are no different than stock in that you can lose money if you try to trade without educating yourself- and knowing the risks.
Some options trading strategies, like selling naked options (which is when you don’t own the underlying stock) are risky. However, if you take the time to school yourself on what successful options traders do and how to do it, that risk is significantly reduced.
And in terms of cost, options allow you to leverage your dollars. If you believe that a $100 stock is going to move higher, you can buy an option contract (remember, 1 contract=100 shares) for around $200 instead of buying 100 shares of stock at $100, which would cost you $10,000. So in that sense, you only have the risk of about 2% of the cost of the stock, which is a significantly smaller cost. Now there is the fixed time component risk that the option carries, but you can choose to learn from me how to manage that risk.
Myth #4. It is a zero sum game or environment
Debunked: If market makers didn’t exist, that may be somewhat true. Common logic would tell you that for every seller, there’s a buyer-and vice versa- and that one of them has to win while the other loses. But that is not necessarily true when it comes to the market maker.
The market maker may be the person that fills a buyer’s order at one strike price while filling a seller’s order at a different strike price…at the same time. The market maker works both sides of the order book and generally doesn’t bet on one direction or another. They are taking the other side of a trade to meet the demand of incoming orders. You and the market maker can both make money eliminating the zero sum game aspect in that case.
Myth #5. Most options expire worthless
Debunked: You may have heard that 90% or more of options expire worthless. That is a warped interpretation of a statistic posted by the Chicago Board Options Exchanges (CBOE) that says that only 10% of options get exercised. But exercising a call option, for example, simply means exercising the right to buy stock at the strike price of that particular option contract.
Just because an option wasn’t exercised doesn’t mean that it expired worthless. That option may have gotten closed out prior to expiration (meaning, in the case of a call option, it was sold back to the markets at either a profit or a loss). If you bought an option, you have the right, but are not obligated, to exercise your right on the stock. So as an option trader, you do just that: buy an option to then sell it at a higher price.
Myth #6. Being assigned stock is a bad thing
Debunked: If you’re transitioning from the world of investing in stocks to the world of trading options, you may feel better knowing that options may be a great tool to use to get paid for buying stock.
If your objective is to own the stock anyway, selling a put option is a way to possibly get this done. When you sell a put, you are giving the market the right to “put” that stock to you at the strike price of your choice.
You get paid by selling the put option…let’s say $2 for one contract (or $200). The strike price sold was the $40 strike, meaning the market can sell the stock to you at $40 per share. The stock drops a bit, say below the strike, and you get sold the stock at $40. You already took in $2 for selling the put option so your basis is $38 to start. And now that you own the stock, you can use the covered call strategy-or just own it for the long haul.
If you use the covered call strategy where you own a stock and sell a call against it at a slightly higher strike price, you are basically accepting selling the stock at that higher price. By selling the call against your stock, you get paid for selling that option. And if your stock goes higher in price and gets assigned, or called, you make money for that as well.
Myth #7. Buying cheaper options is less risky
Debunked: Cheaper isn’t always better. Your education and training on technical analysis will come in handy when determining which option to buy or sell.
Two critical things to assess are: your timeframe and the expected price move for the stock. Let’s take call options for example… Buying calls that are out-of-the-money (OTM) have a higher strike price than the stock price. So to give you an idea, a $50 strike price on a stock trading at $40 is going to be much cheaper than an option at a $35 strike price.
The reason behind the example above is that the market makers are charging less for that $50 strike option because the likelihood of that stock getting to $50 or higher is less probable than a stock that’s already in-the-money (ITM).
The stock can move higher, but still might not get to $50 or higher and at expiration, that option will be worth $0. Now the $35 call may have a loss as well, but it may still have some value left that you can sell it for- and avoid taking 100% loss. If the stock moves enough in your direction, your rate of return may be higher on that cheaper option…But the risk of it being completely worthless may not be worth your time to trade it.
I could go on and on, but those are the biggest myths out there today about options and options trading.
I’ve been involved with trading options for over two decades and have seen too much good that has happened to traders after they clear the hurdles that naiveté and fear present to them.
So when it comes to the great argument that options aren’t a viable way to make money, are too risky, and are best left alone, I’d counter it with proven facts-and win every time.
Options are here to stay and I am here to help educate you on the proper way to use them.
Here’s Your Trading Lesson Summary:
There are many, many myths out there about options and trading options. And with these myths come the fear and doubt that lead to the mistakes that haunt traders forever. So to trade options properly, and without looking over your shoulder each time, these myths need to be put in perspective. Here are three of the seven biggest options myths:
- You need to be a professional trader to trade options
- Understanding options is too difficult to understand
- Options are too risky and you can lose ALL of your money
Until next time…
Happy New Year!
Tom Gentile
