<re: options trading vs. stock trading>
I agree, Eric Options trading deserves at least 10 threads of it's own. I'd like to share a few observations about it that are pertinent to our stock-trading thread discussions, though. As background, I have invested a tremendous amount of time in the past trading individual stock options, and I still trade index options (OEX's) today, although less intensively. Although (somewhat surprisingly to me, given the risks involved) I've made some pretty major bucks trading option positions, I had much more trouble holding on to the gains from options trading, and I finally arrived at the conclusion, after much experience and thought, that stocks are really a superior trading vehicle (for the most part, OEX excluded) for the following reasons.
Options are very alluring to the stock trader because the leverage is so much greater. I would state flatly, unequivocally that it is certainly possible to make a lot more money trading options, than trading stocks. HOWEVER, it is also possible (read: likely) to LOSE a lot more money trading options than trading stocks. And that is what usually happens.
The reason is, with options there are several more things working against you. First of all, you have to pay the (often wide) spread, which can be a substantial portion of the contract price (more than with a stock, generally). Second, you have "the Greeks" to deal with, particularly Delta, which means the options will not "track" the underlying stock 1:1, or even 0.5:1 when it moves - often a big disappointment. Then, you have the implied volatility factor which is built into the pricing model - the option can be "pumped up" when there is excitement in the underlying issue, and "deflated" at any time without changes occurring in the underlying or the passage of time being a requirement (these changes are different than time decay; when short-term trading options the much-noted time decay factor is often less important than you might think). The implied volatility changes occur in a way that makes it harder to "jump" an option in a stock or index that is already moving - inevitably, by the time you want them through TA/momentum etc, they are already "pumped up". Finally (although this is not a complete list) you have to work against the "time decay" (a separate factor than implied volatility), which is steadily decaying the option price the longer you hold it. And one more item, because of the way options move, it is much more difficult (psychologically) to implement a good stop-loss strategy. For many option traders, the stop loss is provided by controlling the size of the position, with each position being subject to a total loss if it goes against them. It IS possible to use stops with options (there are a variety of methods that work), but it is much more difficult to implement than with stocks.
When thinking about option prices, to avoid becoming confused it's important to understand that an option price is composed of two components: the intrinsic value, and the time value ("the juice"). The intrinsic value is related to how far the option is "in the money" (beyond the strike price), and the "time value" is related to how much value the market places on that option between the current time, and expiration. Most of the fancy math, Greeks, etc. relates to how the time value component is valued. It becomes simpler/clearer once you sort the pricing model out.
There are many complex options strategies - spreads, straddles, butterflies, etc. to learn about. Many of these techniques simply serve as a mechanism to entertain the retail option-buyer while they lose their funds. The pro's who trade options generally do so with lower commissions where these complex trades make more sense (most option pros trade volatility, not price direction). Spreads are a conservative way to trade, but profits are meager. Writing covered calls is an excellent profit-booster for the longer-term position trader or investor. Writing naked options (calls and puts) can be very lucrative, and turns the tables on time decay, but it is also very risky.
If you are going to trade options, I feel the most lucrative way to trade them is daytrading them (including overnight swing trades). It is a whole different game/methodology than daytrading stocks though, and it helps to be very good at daytrading stocks first. If I were put into a prison cell, given some capital and told that I couldn't be released until I'd made $X, I would immediately setup for real-time options trading (... could you get me a Pentium III with OptionVue 5. That being said, don't be easily persuaded to try it, because the risks are much higher than stock daytrading - there is so much more leverage and risk.
I spent a couple of years using OptionPro, OptionStation, OptionVue, etc. and reading books/taking seminars learning how all of the Greeks work, how options are priced, etc. before I really got a good handle on, and became comfortable with, option pricing. Until you reach that point, you are working at a severe disadvantage.
With options, the STARTING point for a successful trade is to be right on timing and direction. That does not even come close to assuring a successful trade. With stocks, it is easier to complete a successful trade. The odds are much better trading stocks.
The other danger with options is, you can make so much money so quickly trading them, that you may become too aggressive and set yourself up for serious damage. If you refer back in the thread to my post "The Loser's Spiral - the dark side of trading" this happens to A LOT of options traders. At the brokerages, often the option-broker rooms are referred to as "the Gambling pits". There is a reason for that! However, it is POSSIBLE to trade options in a disciplined fashion, with stops, etc. and to control your position size so that the inevitable "wipe outs" (lost of most or all funds invested in your trades) is tolerable. Think of yesterday - a lot of people buying at-the-money calls, or even in the money calls, lost ALL of their positions in many stocks. X dollars into their trades, zero dollars today. Doesn't happen so easily with stocks!
Anyway the point is, ESPECIALLY for beginning to intermediate traders, you are much better off with trading stocks. Stock traders having the normal difficulties are often lured into options, seeing them as an "easier" way to make a profit. Over time, they are not!
I'd recommend getting very good at stock trading first, then if you want to extend your trading/timing skills into options, do it with a small % of your trading capital, until you've proven to yourself that it's a sustainable profit center.
Good trading, Steve |
