Before you start yelling at me and tell me how can I say they are not good investment if I myself trade them, let me explain what I mean by that. It is true that I trade options, but only for short term trading. I usually get rid of my options in the same day. Let us consider the situation where a person thinks a stock should rise in value in the future. Instead of buying the stock itself, he wants to buy a call option on the stock. A person might do this because of the leverage an option provides.
Some Option Drawbacks
It is true that options provide leverage that can boost profits. The problem is that, unlike a stock, they can lose value pretty quickly and even if the move you waited to happen has happened, you might not profit from it.
Losing Value With Time
Unlike a stock, the option loses value with time. Intuitively, this is because the option has less probability to finish inside the money as time progresses.
Losing Value If Implied Volatility Changes
Lower implied volatility means less chance that the option will finish inside the money, hence causing it’s price to decline.
The above should be a reminder on how NOT to trade options. You don’t buy an option to sit back and look how the option rises in value.
Some Exceptions
Exceptions naturally occur when you use options as hedging tools in conjunction with stocks. Buying a stock and buying a
put is a fairly good idea for the risk averse investor.
Good post overall, but I think your comment under “losing value with time” should say
“…this is because the option has less probability to have a large move in price as time progresses.” Finishing in-the-money or out-of-the-money depends on what the strike is and theoretically there should be close to the same number of strikes selling ITM and OTM. Additionally, for every put that is ITM, the call at the same strike is OTM and vice versa.
Thanks for commenting. I wasn’t that specific as you comment. The key idea though to remember is that options lose value with time. As options have a lower rational bound, as time progresses to expiry, they converge to their intrinsic value and lose their time value. This is true for both put and call options.
Thanks for the comments.
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