Buying Options - A Slow Way To The Poor House
June 2005
Most individuals who are first drawn to traded options think that they’ve found a trading/investing nirvana. Here is a product that (if bought) offers limited risk (the initial cost of the option) alongside unlimited reward (puts actually have a limited reward because the security cannot fall below zero, but due to the inherent leverage involved the profits would still be astronomical).
But the experienced option trader very rarely buy options. So how can one side of the coin (new traders) believe one thing (nirvana), and the other side (the professionals) take the complete opposite view? There are many reasons but the main one has to do with timing.
Timing is the hardest thing to get right in trading or investing. How many times have we all forecast a stock to move considerably higher within say 3 months only to lose money because it actually fell before powering ahead to where we thought in 6 months time. Or for all you day-traders out there, you expect the FTSE to move sharply stronger on Monday, only to lose money. But then on Tuesday or Wednesday the market makes the move.
Timing is the Achilles Heel Of Option Buyers
Imagine if a friend told you that ABC stock was doing everything right in its business but the general market hadn’t yet noticed. He states it’s sure to double over the next 6 months so you buy £2,000 worth. Six months down the line the stock is only up 10% but your friend is still very confident that the market will soon take notice.
Finally after another 6 months the stock does double and you take your profit. Looking back on the trade it didn’t really matter that it took an extra 6 months to move because the financial result was still the same. Timing in effect, while still an important consideration, took a back seat.
But if you’d bought 6 month call options chances are you would have lost all your money even though you’d only really been half wrong (the market hadn’t gone down, it just hadn’t gone up that much).
Buying Options Is Not All Bad
Buying options whether calls or puts does have a place in the traders armoury though, it’s just not all the time. This article is not intended to put people off buying options, rather to let them understand that if you continue to only buy options over a period of years then you will no doubt have some spectacular profits, but these will only go towards paying for the many many losses that you’ll accrue, for the majority of the options will expire worthless.
Education Is The Key
If you want to give yourself the best chance of making money with options overtime then realise education and experience is the key. Start by reading Charles Cottle’s excellent free book available here and by listening in on some of his free webinars – click here for his website.
See Also
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