Trading options is becoming more popular as people realize that they can get into investing without knowing nearly as much about the stock market as those traders who have been around for decades. However, even though trading options is more straightforward than other forms of investing, it does not mean that there are no risks involved.
Table of Contents
Be aware of the risks
New traders need to understand these risks before venturing into this relatively unknown area of finance.
Do not underestimate the probability of failure.
Many beginning traders underestimate the probability of failure and risk losing everything. Another real risk is the amount of money it costs to trade options. If we start trading on a small scale, we can still afford to lose some and still make some on the side, but if we want to start making big trades, we can easily spend thousands on just one trade.
Volatility
Options trades are inherently more risky than simply buying or selling stock directly. This occurs for two main reasons: Firstly, since you never actually own the asset, there is no real limit on how much of your money can be lost if it suddenly plunges in value. Secondly, out-of-the-money options have an infinite price, which means traders need to understand precisely how volatile a market has to get before the difference between the current price and where you “bet” becomes significant enough to cause a problem.
Short-term deals
The other thing about options is that they are often very short-term deals, being in existence for only a few days or weeks before expiring worthless. This will hit novice traders who don’t have the experience to understand what’s going on when the price moves against them, especially since there’s likely to be significant time delays in getting hold of technical information and putting it into practice.
Costs
If we want to become successful at trading options, we need to make large trades. But to do this, we have to spend a lot of money upfront. Where you start doesn’t matter, it’s still going to cost us the same amount. If you want one share of stock, whether or not you buy it on the New York Stock Exchange has no bearing on how much that single share costs. The price of one share is always defined by what people are willing to pay for it at that moment.
Time-consuming
Trading options requires some research into other traders’ behaviour and interests in certain stocks because several different types of options contracts are available. This can be time-consuming because even though there are so many different contracts, some of the terminology used to describe them is not always clear. We need to understand precisely what we can do with these different types of contracts and how that will affect the choices we make as traders.
Use a simple strategy.
The most straightforward option strategy for new traders is probably buying calls (where you get more optimistic about a stock), which gives an advantage over simply “going long” if the asset’s price rises but leaves plenty of room for losses if it doesn’t. Traders can also benefit from selling puts (which benefits from falling prices), but this is only suitable for those with consolidated accounts as it can lead to margin calls.
Bottom Line
If you’re new to trading, keep things simple, avoid options altogether, or confine yourself to the most basic strategy, such as covered calls. This will cut down your risk and give you a good chance of making money, even if it’s not as spectacular as some people want you to believe. New traders should use a reputable online broker like Saxo Bank to help them get started. For more information, visit the site here.
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