I have been studying options recently and have had this question keep popping up in my head... Why options vs outright positions? I am still on the basics of options, so forgive my ignorance on the subject. In my reading so far I keep coming across the concepts of direction and timing. Direction and timing are what is necessary to make money in trading an outright, so therefore if you must also have direction and timing for trading options, then what is the main benefit of options vs just trading outrights? I haven't delved into the more arcane aspects of options yet, only the basics, so maybe I will find the answers there. I have Natenberg on order, and have some of Cottle's info, including his book. I just wanted to ask some of the more experienced traders here what they thought about this question. What are the benefits options provide vs just trading outrights? I am curious to see the benefits, because it just seems on the surface that options are a way of complicating outright trades. I don't think this is true, I just don't know any better yet, so I would appreciate any input anyone here who trades options can offer. Thanks in advance for your help.
Options provide leverage and its a double edged sword, cuts both ways. Options are tools when mastered and can be used with any number of stock and indexes strategies. Directional trading is the worst kind of probability game. Options provide leverage you cannot muster otherwise in any other way. For example instead of buying BIDU ( if its going to be bullish pretty soon) in a directional trade I would not buy stock. Buying 500 shares cost your $100,000 while shorting few deep in the money puts gives you a margin requirement of $30,000 for 500 deltas which is the same as your stock position. The results are not identical but close. For options trading read Larry McMillan's " OPTIONS AS STRATEGIC INVESTMENT" the Bible on Options trading. Sheldon Natenburg and Charles Cottle is way too hard and good for advanced users only.
That's a loaded question, so i will just give 3 simple examples i am sure the more experienced can explain it better. 1) To buy 100 shares of goog cost $43300, to control the same 100 shares using option (1 contract atm call) cost - leap 09 expiration=$6700, jun 08=$3800 etc.. You get to control the same # of shares for about 5x-10x less capital depends on expiration. the downside of course is now there is time decay against you, and <1 delta 2) If you think a stock will move sideways, how do you profit from it just trading the stock? you cant. With option you can with short strangle, iron condor etc.. 3) if you are buying 100 shares of goog right now at $433, you can also sell 1 contract of goog april put of 430 at $2100 instead. If google drops to 430 at expiration, you bought it $24 cheaper, if google moves up instead, you close out and keep the $2100 (or portion of it). Downside of course is if google gaps up $200 dollar, you will still only make $21 - the put you sold There is no free money, but options adds another tool to your trading arsenal. You still have to make the right prediction on the underlying stock to be profitable trading options. I lost a lot of money trading options and just starting to grasp their fundamentals. good luck
Thanks for the info, would you say the benefit of leverage that options offer the retail trader would still apply in futures, where the outright contracts are already highly leveraged? Thanks again.
Thanks for the help newguy05. Wasn't trying to ask a loaded question, just wasn't sure the best way to ask. I appreciate the info.
Most important thing to learn, always be the seller of options than a buyer. Start small and go to www.cboe.com and take those free webinars hosted by Dan Sheridan. Say hi to Dan from me..
are there any decent blogs related to spread trading on options? I would like to take a look at an actual trade in the making.
Options are unmatched in opportunities and dangers. From your post, I am guessing that you are looking at options as a buyer. A major benefit to the buyer is the 24hrs stop loss (market stops did not save BSC investors, but buyers of puts I am sure were happy to have bought put insurance). The win probs are on the side of the seller of options, but the sellers are not in good position either as their loss can be large but their life is less complicated in regard to the complexities you raised. You may now say, but what the heck, sellers and buyers are in a nightmare. You would be right. But what does not always occur to the people is that if you can be BOTH a seller and a buyer of of certain options you have already a good part of the game understood. It is called spreading (a hedge against being wrong). So, you need to be a good spreader and read all posts in here with regard to many other principles you need to cover, etc. Note that not all spreads are good. For instance, buyin a call and selling a put is the same at the futures, which is also equivalent to holding a long position. So with spreading, you can re-build the underlying stock and the future derivative behaviour. You can also think of option traders as sellers and buyers of stops that work 24-hours. A sort of insurer and re-insurer of dangerous animals (more dangerous than drivers, or even the hurricanes). The above should be enough for the moment to keep you busy. Some time in the future you will starting going in other areas. Options is also a place where you can do banking (lending, borrowing, and speculating on interest rates). Anything that can be done in markets is in it (just stuffed in the price in a way that the more you learn about it the more you see the hidden aspects). By the way, did you internalize volatility yet? If there is one concept that I think people have difficulty with in options, I would say it would be volatility. I do not know why, but they just do. Welcome abroad and watch for your wallet (options can stretch it before they learn how to stuff it-- with the green stuff of course). As casinos like to say, casinos do not beat you, odds do. So you fellow traders do not beat you, options/odds do. But I think that you will sit on the winner side if not at the beginning, soon afterwards. Wish you well.
I do not like the book of McMillan. No insight. Sheldon is good. My best book is the thesis of Bachelier (dated 1900). That guy had it all figured out.