10 Busted Myths About Options Trading
05/14/2015 8:00 am EST
Common misconceptions often keep traders and investors out of the options markets, writes Jim Woods, contributor to InvestorPlace.com, laying to rest ten of the most notorious option myths around.
For the past several years, cable TV viewers have made the show MythBusters a huge hit. The program takes a group of experts who use basic elements of the scientific method to test the validity of various rumors, urban legends, and myths found in everything from movie scenes to pop culture to ancient history. Based on the results of the team's tests, a myth would be either "confirmed" or "busted."
Well, at OptionsZone, we have our own set of MythBusters. Our team of experts is comprised of CEOs from the top options trading firms. Industry luminaries such as Tom Sosnoff of thinkorswim, George Ruhana of OptionsHouse, Wade Cooperman of tradeMONSTER, Don Montanaro of TradeKing, and Stephen Ehrlich of Lightspeed, all sat down with us and gave us their thoughts on trends in the options market for this article.
By picking their brains on a variety of issues, we've uncovered ten options trading myths that we've summarily declared "busted!"
Myth #1: Options Trading Is Only for Professionals with Years of Experience
Although it has long been held that trading options should be left to only the most-experienced traders, in recent years, this notion has changed.
According to Tom Sosnoff, "I think [options trading] has become [widely] accepted now. Five to seven years ago, it was on the fringe. Ten years ago it was an alternative investment. Now trading options with penny wide markets and the ultimate competition for order flow, it's like trading stocks."
George Ruhana of OptionsHouse agrees. "I think that there's no question that [options] get accepted more every year..."
Options trading just for the pros? Myth busted!
Myth #2: You Should Only Trade Options in a Tax-Deferred Account
We're not sure how this myth got started, but it is absolutely not true. According to George Ruhana, many investors are using options in their taxable accounts to help them make big returns precisely for their retirement planning.
"You've got this huge baby-boomer generation that's got a lot of net worth to invest and they also have some time on their hands, if they're retired, to do so. So people are really involved in [options trading] and they spend a lot of time on it. Trust me, when I talk to customers, they are laser focused on returns and how they're trading and new ways to do things."
George added that many investors are now taking 5% or 10% of their total portfolios and actively trading it in options using both long and short strategies and by buying and selling puts and calls.
Trade options only in tax-deferred accounts? Myth busted!
Myth #3: Option Trade Execution Is a Rip-off
Some believe market makers have it fixed so they make the big money while the individual investor gets stiffed. This myth is simply a vestige of a market where trades were executed only by the market makers. Thanks to the advent of technology, things are done completely differently now.
According to Tom Sosnoff, "We've come from essentially an archaic open outcry system with non-competitive marketplaces to a very competitive, multi-exchange-listed, efficient world of trading. The option marketplace changes have been more dramatic than anywhere else just because of all the different exchanges competing for the same order flow."
The reality in the options markets now is that technology combined with greater competition for trade execution has added a high-level of openness and transparency to the trade. This environment ensures that options trades are executed at the best price available for virtually every trader.
Options execution a rigged game? Myth busted!
Myth #4: Option Trading Will Be Dead When Normal Market Volatility Returns
The short answer here is.no way. This myth is effectively busted by Wade Cooperman of tradeMONSTER, who told us, "The market's been growing in volatility for a long, long, long time. The reality is that volatility is here to stay. It will continue The VIX may go up or down, but volatility is part of investing."
Don Montanaro of TradeKing likens options trading and price volatility to buying insurance in Florida hurricane season. "Those of us down here in Florida are hip to the annual hurricane season, and if you go and try and buy hurricane insurance in the middle of a hurricane, somebody's going to charge you more for it than if you [buy] in the middle of the winter.when hurricanes are six months away."
The point here is that while volatility will wax and wane, options trading can be used to make profits in either relatively stable or violently volatile markets.
Options trading will fade out when volatility fades? Myth busted!
Myth #5: Option Trading Is for Older and Wiser Investors Only
The idea that younger people don't have enough money or experience to trade options is most definitely a myth that's being busted every day by the huge influx of individual investors into the options marketplace.
As George Ruhana told us, "We have watched the growth of the options market and the retail option space. And they get accepted more every year...the other part of it is that [for] younger people who are much more comfortable with technology and the idea of online investing, options investing isn't going to be as big of a hurdle."
George added that although option trading has reached a sound level of acceptance, he still thinks there's a huge room for advancement. "In the long-term, the demographics for options investing are great given that it's not anywhere near its full saturation level."
Option trading only for older, wiser investors? Myth busted!
Myth #6: Option Trades Are Difficult to Execute and Should Be Handled Only by Professionals
The myth that options trades are difficult to execute is a byproduct of that bygone era when user-friendly options trading platforms didn't exist. The new generation of online trading platforms are easy to use, intuitive, and contain sophisticated guidance tools that make trades easy to execute and understand.
George Ruhana says, "I think our platform and our options chain is great. That's because number one, it refreshes; you're seeing data consistently updated. Two, it's easy to create spreads, because it's just right click and do that."
All of our CEOs extolled the virtues of their online trading platforms, which all were specifically designed to make order execution as easy as a few intelligent clicks of a mouse.
Options trades difficult to execute? Myth busted!
Myth #7: Specialty Brokerages Are Good for Trading Options, But Not Stocks or ETFs
Although options-specific brokerage firms such as thinkorswim, OptionsHouse, TradeKing, tradeMONSTER, and Lightspeed all specialize in options execution, they all are also great platforms for trading virtually any type of security.
All of these firms were designed to handle basic stock trades, ETF trades, and mutual fund purchases and sells. In most cases, the low-cost trading that each of these firms offer makes them very competitive when it comes to trading most types of securities. With these specialty options trading brokerages, you can do all your complex options trades, in addition to the easy trades like buying and selling stocks, all at very competitive prices.
Options brokerages are only good for options? Myth busted!
Myth #8: You Have to Spend Thousands on a Good Options Trading Education
In the past, it was true that you had to either be in the securities business to get a good options education or you had to pay a professional a lot of money to learn about the options game. All that has changed, however, with the advent of the Internet and the various trading platforms offered via the options brokerages we spoke with.
According to Wade Cooperman, "The breadth of education and access to education has changed significantly, allowing people to understand more about tools like options..There are just more opportunities for that today than there were 15 years ago."
Tom Sosnoff says, "It was firms like thinkorswim that brought about another level of investor education. Basically, we saw the market moving away from traditional investor education as being a function of technical analysis to investor education being a function of strategy."
The focus on investor strategy is the real difference between the new breed of options trading firms. These firms are dedicated to helping you execute trades and understand the strategies behind why those trades work.
Spending thousands on options education? Myth busted!
Myth #9: Trading Options Is a Function of Greed and Shows a Lack of
Control by Individual Traders
Rather than a function of greed or a lack of control on behalf of individual investors, trading options represents a very controlled and very rational method of adding value to an investment portfolio.
As George Ruhana told us, "They [individual investors] are going to be more personally involved in their financial decisions and their financial future. They're not just going to outsource it to someone with a blank check because a lot of those people got hurt just as bad as an individual investor."
Tom Sosnoff says, "Well I think [market declines] have given individual traders even more reason to be focused on their ability to trade. These are people that are managing their own capital. They're not complaining that somebody else lost their money for them. They're into it."
Rather than simply relying on someone else to manage their money, individual investors who trade options use them to protect principal, earn income, and more importantly, increase control over their own money.
Greed and a lack of control? Myth busted!
Myth #10: Options Trading Is a Fad and Volume Will Fall off Once the Market Settles
For those who still harbor the myth that options are a fad, we offer you the
"I think that people are going to start to take control of their finances just like they take control of buying their own airplane tickets and just like they take control of a lot of things in life that they may not have done 15 or 20 years ago," says Tom Sosnoff. This just means that more and more individual investors will continue trading options.
According to Don Montanaro, "If you look at the full universe of people in this country who have a relationship with a brokerage firm, you are looking at 2% or 3% of those clients—at most—that have accounts that are approved for trading options. So, 97%-98% of people who have brokerage accounts and relationships in this country are not even approved for options trading. What's neat is that because of a lot of the innovation in products over the last several years, that 97%-98% of people is becoming more and more aware of the existence of options and what they're for."
A fad? We think not. Myth busted!
By Jim Woods, contributor, InvestorPlace.com