Are Long Options Really a Long Shot?
11/19/2015 8:00 am EST
About 75% of all long calls and puts expire worthless. So why bother with them if the odds are against you, asks Michael Thomsett of ThomsettOptions.com.
I think this statistic deserves another look. There might be serious reasons to speculate in long or short calls. Consider the following:
- If you are swing trading and using reliable and confirmed reversal
signals, your odds of good timing go up. Buying calls at a short-term low or
puts at a short-term high swing increases that 3-to-1 against you to something
better, maybe even more than a 50-50.
- Also with swing trading, using very short-term long options is sensible.
Swing traders expect a three- to five-session turnaround. So options expiring
in three or four weeks, opened at the money, are going to be most responsive
to price movement in the underlying. Long
puts are bearish plays at the top of the swing, but vastly less risky and
cheaper than shorting stock. This alone makes the long option swing trade a
worthwhile endeavor; and because options are so much cheaper than shares of
the underlying, options open up the way to better diversification as well.
- If you use other reliable reversal signals, like some candlesticks for
example, you can really beat the odds. Strong candlestick reversals like the
engulfing pattern are extremely reliable and, when confirmed, give you a much
better chance for short-term profits.
- Long positions can serve a purpose beyond mere speculation. For example,
if you are long stock and you experience a sudden decline, buy calls not only
to ride the wave back up, but to make a little extra profit at the same time.
If the price has soared and you expect some retracement, a long put can be
profitable and also provides you with insurance of those paper profits.
- Buying calls or puts as the entire strategy is only one of many ways you
can use them. In practice, long positions end up as one side of more involved
spread or straddle
positions. For example, if you are short an option and the underlying
moves against you, the added risk is efficiently and affordably offset by a
long option. This sets up a spread or straddle against the original short
position without the complexity of closing down or rolling the risk and
If you take a new look at long options, you are likely to conclude that the 75% rule is an average and it can be beaten. In addition, long options are very effective when used to manage your portfolio, create short-term profits, or swing trade. For swing trading, long options are better leverage than shares of stock, and lower-risk as well.
A wise rule of thumb when it comes to options is this: Don't rely on the common "knowledge" about risk levels. The more you study options, the more twists and turns you discover. Risk is not a fixed and unchanging feature to all options. What matters is how and when you use them.
By Michael Thomsett of ThomsettOptions.com