Most people believe that option players are extreme risk takers. After all, they purchase an asset with a very short life, and hope it skyrockets in value. Option buyers might make 500% or more if they buy the right option, just as they would do if they picked the winning horse at the track
The waiting period to see if you’re a big winner is a little longer than a horse race, but not much. In a month or two, if the stock does not go way up, you lose your entire investment bet. Just tear up your ticket. You picked the wrong horse.
If the stock stays flat, most option buyers lose their entire bet as well. No wonder people think option trading is risky. At least if you buy a stock, and it stays flat, you don’t lose anything but the opportunity to have done better in another investment.
When you buy an option, it is a declining asset. It depreciates faster than a new car. It becomes worthless in a matter of months.
High-risk, high reward – that is an investment fact embraced by most people. They believe that any system that offers the opportunity for extraordinary profits must necessarily involve an inordinately high degree of risk.
As far as I am concerned, nothing could be further from the truth when it comes to intelligent options trading.
I am reminded of the legend of the blind men examining an elephant – each man touched a single part of the animal, and came to an entirely different conclusion as to what he was touching.
Viewed as single transactions, the following two statements are undeniably true:
1) Buying stock options is extremely risky.
Buying stock options may indeed be the risky kind of investment that scares most prudent investors. If we examined this one small part of stock market investing, we could understandably conclude that stock options investing involved high risk.
2) Selling stock options is even more risky.
Selling stock options, when viewed as a single transaction, is even worse! Selling an option alone is called selling naked (because that’s how you feel the whole time you have that short sale in your account). You have the possibility of unlimited risk. You can lose many times more money than you invested. At least at the horse race, you only lose the money you bet.
No wonder people believe that stock options investing is risky. There seems to be extreme risk all around. Just like the blind men examining the elephant, they are only looking at a single part of the picture.
Since most people have not made the effort to understand stock options, they quickly conclude that the risk level is too high for them, and put their money into a “safe” place like mutual funds. Somehow if they are paying some “expert” to pick the stocks they own, they delude themselves into believing they are investing prudently.
Nothing could be further from the truth.
If your money is in a “safe” mutual fund, these are the facts:
1) If stocks go up, you will make money (but your profits will be reduced by the management fees, sales fees, and expenses you incur). For the past 50 years, the stock market has gained an average of about 10% a year. That is the most gain you should expect with your mutual fund investments.
2) If stocks stay flat, you lose money (management fees and inflation reduce the value of your holdings).
3) If stocks go down in value, you lose money.
Contrast those facts with the case of a properly executed stock options investment
1) If the underlying stock goes up, you make money, often at a rate of over 100% a year.
2) If the underlying stock stays flat, you make money, often at a rate of over 100% a year.
3) If the underlying stock goes down, you may still make a profit. Only if the stock goes down a great deal in a very short time will you lose money. (Of course, your mutual fund would get clobbered in this scenario as well.)
Which of the above two investments seems to be the most risky? It seems to me that the mutual fund investment is a whole lot riskier than the stock options investment (not to mention that it yields a profit of only 1/10th what the stock option portfolio might gain).
Why then does stock option investing get such a bad rap on the risk issue? It is clearly due to the fact that people look at only a single part of the picture (buying or selling options) and ignore the total picture.
They conclude that if buying options is dangerous, and selling options is even more dangerous, that option trading must be doubly dangerous. It does not occur to most people that a system of simultaneously buying and selling options might be even less risky than owning the stock. This is the case, but most people never take the next step and learn the truth.
The truth is that a properly-executed stock options strategy is considerably less risky than the purchase of stock or a mutual fund. However, it takes work. You will have to learn a little about how options work, and be an active part of the investment process. You can’t plunk down your money like you do with a mutual fund, and passively ignore your investment.
The fact that stock options investing takes work discourages most people from even considering an investment in stock options. That is fine with me. When I compare my returns each year with what the mutual funds are making, I feel like a real winner. I may work a little harder, but that’s a small price to pay for the returns I make.
Mr. Cyriac J. Kandathil, Chief adviser AssuredGain.com
Note: I hope this will be eye opener for all those who have failed to make money using options – Narendar Rathod, AssuredGain.com – Trade Wisely and Relax.