Option Trading- A Myth or Boon (Part 1)

In trading world, there is a general misconception that an option trading is very risky. Options can be risky, but not always. Options can be less risky or more risky, depending on your risk tolerance. They can be used for speculation, but also for hedging and protection of leverage. There is more than one way to make money with options. Here are some of the common myths and misconceptions about options trading.

1) It is easy to make money with options

There are many experts who promise to make you money with no effort, they charge you  thousands and lakhs of Rupees. They present some of the highest risk strategies (like trading weekly options) as “low or no risk”.

The truth is that learning how to trade and invest successfully requires a lifetime of work, dedication, and focus. Not only is there a long and difficult learning curve just to learn the basic fundamentals, but you’ll soon discover that being a student of the markets never ends. To become an engineer you have to study 4 years, and probably another 4 years  to become a good one. So Why do we expect it to be different when it comes to trading?

2) The only profitable way to trade is buying call or put

This is a very common misconception. While it is true that buying calls or puts can be very profitable, it is also a more risky way to trade. When you buy calls or puts, you have to be right three times:

• Direction of the move (direction of trade)
• Size of the move (how much the trade will move)
• Timing of the move (entering at right time)

The underlying has to move in the right direction, and fast. You can predict the direction and the size of the move right, but if the move happens after the options expired, you lose money. Even if everything works in your favor, but Implied Volatility collapses (after earnings for example) you might still lose money.

3) Options are total speculations

The truth is that options can be used in many ways. They can be used for speculation, but also for hedging, protection, income etc. For example:

• An investor who is long a stock but is concerned about short term volatility, can buy protective puts to hedge his investment.
• An investor who believes the market will be trading in a range, can trade range of income producing stratgies, like calendar spread
• An investor who wants to buy a stock at discount can use a naked put strategy

We will continue with more option myths in our next blog.