It's a human tendency to cross-check whenever we encounter something new, whether if it is dangerous, read up reviews on it before giving it a try.
It is even more human nature to assume everything unknown to be dangerous. This could be a good habit and it can definitely save us from certain disasters.
However, how we come to the conclusion that something is dangerous matters a lot. Turning away from new knowledge simply because you assume it’s dangerous is no way to make you a better trader.
In order to be a successful and sustainable trader, we need to have an open mind to explore various financial tools and make the best use of them.
Most people have at least tried buying stocks by themselves; few have considered adding options to their list of strategies.
In 2020, when the stock market was ripping crazily, even people with zero to little investment experience opened their first trading accounts and started to buy shares.
The reason is simple because the concept of buying shares is simple.
For example, if you like Tesla or Elon Musk, all you need to do is to search for the stock ticker TSLA at your brokerage platform and click on buy.
Since for U.S. shares, one lot is 1 share, you can argue your risk exposure is not much because you only bought a few shares. You know clearly if the share price goes up you make money, and if the share price goes down you will lose money.
However, rarely do you hear people who have little options trading experience open a trading account and start to trade options.
Well, you definitely need to know how the option works before you can trade options. That’s not what I want to discuss here. Granted, trading an option is more complicated than buying or selling a stock. Nonetheless, being simple doesn’t mean it’s safe, and being complicated doesn’t mean it’s dangerous.
Imagine if you’re holding 100 shares of Apple which you bought at $120. Regardless of your belief in Apple, your total risk exposure is $12,000.
Did you know that with an option, to have the similar effect of holding 100 Apple shares, your risk exposure can be reduced to $700? Is it dangerous with the introduction of options or is it not really the case?
While the option is a beautiful tool with which you can construct amazing strategies, in this article I will assume you have little options trading background and will use some basic options concepts and explain to you why trading options are no riskier than trading stocks. In fact, it’s far less risky.
When you are the buyer of an option, you will know your maximum loss before you place the trade. Below is the characteristic of buying an option shown in Figure 1 and Figure 2. I will use two examples to give you a better perspective.
Buy a Call to benefit from a bullish move
Buy a Put option to benefit from a bearish move
I am not here to ask you to abandon stock trading completely and dive all into options trading. Stock and options trading can go hand in hand and these two financial tools together can construct beautiful strategies.
The fact you are reading this article shows that you are starting to open your mind to a new financial tool, options trading. You might hear people talk about options but you don’t really know how to trade them. The unknown is often in disguise as a danger, the best way to reveal its true value is through education.
Options are more complicated than stock because the calculation of option price involves more variables than that of a stock. You don’t need to be a mathematician and calculate the option price as it’s auto-calculated by market makers.
However, you do need to know how is an option price being affected by certain variables and this is the gap you have close with education.
Know your risk is the key. Before you open a position, you must know what your risk is and make sure you are comfortable with the risk.
Never ever open a position due to greed, because things don’t always go in your way. If you can make sure you follow this each time, you have already saved yourself loads of money.
I hope you enjoyed this article. See you again in the next one.
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