Myths About Trading Options

Options are too complicated

This is nonsense! In many ways, learning to trade options is easier than learning to trade stocks. Think of it like this. There are only two types of options, puts and calls. Puts allow you to bet that the price of a security is going down, and calls allow you to make money when the price of your equity goes up. Pretty simple, right? And if you limit the number of securities on which you trade options, you make things even easier on yourself.

Options are high risk

They certainly can be! So can flying or driving a car. It all depends on the operator. While it's true that some options are highly risky, there are trades available in the options market that will appeal to the most conservative investor. The beauty of options is that you get to choose your approach based on your own unique level of risk tolerance.

Most people who trade options lose money

Options are a zero sum game, which means that on every trade there is a winner and a loser. There are also commissions to factor into the equation. In our experience, speculators trying to make a killing typically end up losing money. Meanwhile, more sophisticated traders with a solid plan, end up with the lions share of the profits. Our advice is that you don't take high risk trades unless you can afford the expected loss.

80% of options expire worthless

This widely accepted notion may or may not be true. It will depend on the option selected. Options that trade out-of-the-money are highly likely to expire worthless. Options with a strike price (exercise price) at-the-money have a 50/50 chance of finishing in the money. And options which trade in-the-money are highly likely to finish in the money. You have the choice to only take trades that are probable to finish with a profit.

Options are for speculators

This is another very common misconception. Many options traders use options instruments to hedge other investments in their portfolio. An example would be purchasing a put against a stock you currently own to protect against a downward price movement. Or buying call options against a stock you've sold short in order to cap your loss on the position. You could even sell call options against a current equity to generate income while taking no risk at all. Options are for much more than speculating on the direction of a security.

Trading options requires a lot of capital

Most brokerage firms will allow investors to open an account with just a few thousand dollars. Because options are a leveraged investment, a little bit of money can control a substantial amount of a stock, ETF, or index. One of the most attractive features of trading options is that it requires a limited amount of capital.

You should start by trading stocks before trying options

That's like saying that you should learn to ride a horse before trying to drive a car. They are two different animals. The challenge with this philosophy is that it takes a lot of capital to play in the stock market. If you were interested in owning IBM, and if that the stock were trading for $200 per share, 100 shares would set you back $20,000! Plus, you would have $20,000 at risk. Instead, you could control 100 shares of IBM for a fraction of the investment.

When you dig a little deeper, you'll find that most of the myths perpetrated regarding options are offered by individuals who have absolutely no idea what they're talking about. If you want to know the truth about trading options, talk to an options trader. The reason they trade options is that it works, provided you use the right approach.

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