Why You Should Trade Options
12/25/2012 8:30 am EST
Options are far easier to trade and accessible than in years past, and now offer the power of leverage, liquidity, and variety for investors, says Dan Passarelli.
Why trade options? We’re here with Dan Passarelli, who’s going to talk to us about why investors should trade options.
Well, there’s a number of reasons. Options offer certain advantages over traditional investing by simply buying stocks.
For one, leverage. Trades who want to take an aggressive plan in a particular stock can do so very, very efficiently by using options. Options offer really, really great liquidity these days. They offer great leverage, and there’s a whole number of different stocks that people can trade options on.
It’s becoming increasingly popular to use options, too, so the strategies are getting a little bit more universal, as far as investors understanding how to trade them, learning where the contracts are, and especially with brokerages allowing them to get involved a little bit easier than in the past, right?
Yeah, it sure is. I mean, if you look at the numbers—you look at the growth in stock trading volume versus the growth in option trading volume—option trading volume is increasing significantly year after year after year, whereas stock trading volume really isn’t, so they’re becoming much more popular. You hit it right on the head.
The brokers are reacting to that. Brokers are making it really, really easy for people to trade options, and they’re offering a whole host of different tools that option traders can use.
There’s one, I think, misnomer that a lot of investors have with the options market, and that is that they look at it sort of like a horse race, where they figure because they have leverage, they’re going to go for it, and they want to leverage big-time profits, they want the homer every time, and it’s really more of a singles, doubles kind of thing. It’s better to be Ty Cobb in the options market than it is to be Babe Ruth.
Yeah, and that brings me to the second thing that options provide over traditional stock investing. They provide protection as well. In fact, they actually combine protection with leverage.
A trader could go and buy 100 shares of say, a $50 stock, and have really $5,000 at risk. Now, it’s not very likely the stock will fall all the way to zero and go into bankruptcy and the investor would lose his full $5,000. But time to time, the market can really take it on the chin, and it’s not uncommon to lose maybe $500, $1000, up to 20% or something.
What a trader can do instead is buy a call that represents the rights on those 100 shares, so there a trader might pay something like maybe $300, a very small fraction of the capital that’s at risk if he were to instead buy shares of the stock. But if the market goes his way, the investor can make so much—well, the investor can make just as much or at least almost just as much buying the call as opposed to buying the stock. With similar reward and less risk, in my opinion, options are just a superior investment vehicle.