Today we'll be discussing the differences between investing with stocks and options. Let's first tackle the less complex investing vehicle, stocks. Most of the world already knows, but in case you don't, stocks are directional trading vehicles. If we are long the stock, then we make money when the prices of the asset rises, and we lose capital as the underlying asset drops in price. We can also sell a stock short in which the profit comes when the stock falls. In any case when investing with stocks, the direction is what matters. We don't need to worry about market volatility or time.
So we all know that stocks are simple, directional investments, but what about options? Well, trading options is actually trading 3 Dimensions...time, volatility and direction. I guess this makes options three times more complex than stocks. Now, let's look at a trading example to compare the difference. Look at this scenario:
A stock takes a full year to move up 10%. The stock trader who bought and held on to his stock has just made 10% on this particular trade. However, the option trader might have made nothing at all or even lost money if he just bought an option.
So why did the option trader lose money if the stock went up? Well, it's quite simple really. The option trader lost the time value of his options. Each option has time premium factored into the option price, and if the move doesn't happen fast, then the option trader will most likely lose money if he is simply buying Calls. Also, the volatility will most likely drop on the asset as the price rises, and this will also cause the price of the option to fall.
This is why we need to be educated in order to trade options. Simply buying Calls and Puts makes option trading very difficult because of the elements of time and volatility. Remember, options are three-dimensional vehicles, and if we don't understand how to manage these 3 complexities, we shouldn't trade them. After we understand options more in depth, these investment vehicles can make money in any type of market. Options are very adaptable and allow investors to be very creative once the understanding is there. - 29971
So we all know that stocks are simple, directional investments, but what about options? Well, trading options is actually trading 3 Dimensions...time, volatility and direction. I guess this makes options three times more complex than stocks. Now, let's look at a trading example to compare the difference. Look at this scenario:
A stock takes a full year to move up 10%. The stock trader who bought and held on to his stock has just made 10% on this particular trade. However, the option trader might have made nothing at all or even lost money if he just bought an option.
So why did the option trader lose money if the stock went up? Well, it's quite simple really. The option trader lost the time value of his options. Each option has time premium factored into the option price, and if the move doesn't happen fast, then the option trader will most likely lose money if he is simply buying Calls. Also, the volatility will most likely drop on the asset as the price rises, and this will also cause the price of the option to fall.
This is why we need to be educated in order to trade options. Simply buying Calls and Puts makes option trading very difficult because of the elements of time and volatility. Remember, options are three-dimensional vehicles, and if we don't understand how to manage these 3 complexities, we shouldn't trade them. After we understand options more in depth, these investment vehicles can make money in any type of market. Options are very adaptable and allow investors to be very creative once the understanding is there. - 29971
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