Time and again, I have seen people talk about options as if options are from different planet and something average investor or trader can’t make money with? Are options really that bad? I mean, do people even understand what options are before they start trading options? A lot of money is being made in options. I mean, a lot. Even Warren Buffett trades options. Options can’t be as bad as people make out, can they?
As someone who has been writing about options for 90+ months, I thought to clear some of the biggest myths about options. With this new series of articles my intention is to introduce you to a framework that gives ideas on how to think about options and reasons on why you shouldn’t or should trade options. Once you understand the “WHY”, you can find tons of options trading books in the market which can introduce you to options language should you decide to trade those.
The Objective of this series is to tell you, in plain simple language, the pros-n-cons of options.
Most people are familiar with stocks. Usually, you find someone either within your family or close proximity who “knows” stocks. You are also taught about stocks in traditional educational system. It’s been there for 100+ years. Even our grandparent knew what stocks are. We all understand “Buy Low, Sell High”. It’s just so easy. We are told to buy it for the long run. Buy and Hold is the Mantra. Just keep it and over the long run stock market will deliver 6% annual gains*.
When it comes to stocks, we know it all. Even though within the stocks there are different type of investors e.g. a) Value Investors, b) Technical Analysts, c) Pattern or Momentum traders and a few more, the end result is same i.e. Buy Low, Sell High (and/or keep collecting dividends if the stock pays it). And it makes money if goes up, and lose if it drops.
Everyone knows what stocks are. But when it come to options..Huh!!! What the heck is that?
You see, by the time, we get to hear what options are; we are pretty much done with the “traditional learning phase” of life (generally speaking). We start to learn using “comparative language”. options compares to…stocks…and since there are hardly handful of people surrounding us who understand (leave aside trading) what options are…..it makes it even more challenging to familiarize with options.
So the first thing typically a new option trader does is to TRADE OPTIONS LIKE STOCKS. Because it what he or she understands best. He buys the options with “Buy Low, Sell High” objective and if the underlying asset doesn’t move, he becomes a long term trader, just like buying and holding the stocks. Or worst, he is right about the direction, but his option still doesn’t make money. Ouch!! Needless to say, the story doesn’t end well. And immediately the conclusion is, OPTIONS ARE COMPLICATED. Over 90% of the new options traders I met or talked with fall into this category. They started trading options like stocks.
Let’s see. We assume that you know something about a particular undervalued stock that others don’t (that’s why you purchased the stocks at first place, right?). After buying “that” stock, it is either going up or down. Your stocks make money or doesn’t make money. It’s easy to understand. You don’t have to deal with numbers (right? We assume that you are on top of financial statements and business projections every quarter).
But with options, you have many more tools at your disposal. You can still make money even if you are wrong (just not too wrong)!! Ouch? How’s that possible? We never heard that before? It must be a scam? It can’t be true? There must be a catch?
Oh by the way, did I say that depending upon your knowledge level, you can create a stock position without ever buying stocks? Or how about being paid to buy your favourite stock at much lower prices than current market prices?
No way, you are making my head spin. It’s confusing. You are talking non-sense. Isn’t it? You have given me too many choices. I don’t like it, let me keep it simple and straight (KISS) and trade options like I trade stocks. I know how that works.
That’s THE RECIPIE FOR DISASTER.
The more the choices, the more confusion. On one hand we want simplicity; on the other hand, we want flexibility.
Stocks are like simple pocket knife; while options are like a Swiss knife.
It offers you many more tools, much more flexibility than plain simple pocket knife. Stock traders trades with “certainty” i.e. he thinks he knows the future and thus he needs only knife, but option trader trades with “uncertainty” i.e. anything can happen in the markets and thus he will use appropriate tool as the market situation demands.
Do you want to be the majority that loses money or minority that makes money?
If you want to be the minority, then you have to do what that minority does. They treat trading as business. And operating a business requires understanding of everything that touches your business. You can’t leave it for chance. If you are so sure that so-and-so stocks are going up but you don’t want mumbo-jumbo of options trading, just trade the stock and forget about options.
But if you are not certain about future but still want better returns via trading options then You have to trade options like options NOT like stocks.
Mindshift is THE prerequisite.
What do you think? What other topic would you like me to cover on Options?