As your investment knowledge grows, you may be wondering what else is out there that you can trade besides stocks. There are a variety of other investments such as forex, commodities and options. Today, I will focus on options but you should give the other two a look over as well. Options have been deemed as risky and gambling assets. While there is some truth to that, it is not entirely. Options can be great hedging tools on your long term stock positions. For instance, say you own 100 shares of Apple Inc. (AAPL). Maybe you think that some new product releases will give the company a nice earnings boost but the current market conditions increasingly look bearish. Rather than sell your whole position, you could buy a put option to protect your Apple position from any downside. Remember, one options contract represents 100 shares.
Unfortunately, a majority of people who trade options use it as a speculative device. As I said above, one contract is 100 shares and contracts can be extremely cheap. The scary part is that options are highly leveraged, meaning you can control a lot of shares of stock for a cheap upfront premium. Options rely on margin as well which could get you in big trouble with your broker if the option prices crash.
While options tempt us with their extremely large profit potential, there is a huge underlying risk involved that wins most of the time. Beginners love options because of how leveraged they are but, they scratch their head when the stock price goes up but their call option falls in value. Greed takes over and they do not do the proper homework involved to be successful.
To be successful in options, you must first educate yourself. This includes learning what options are and how they are affected by different market conditions. Option Greeks are often ignored by traders but they give some of the most important signals that could tell you whether your trade is predestined to fail. Please read my prior article on the Greeks for a very basic overview of some of the different ones.
As a general rule, options are not for beginners or for anyone who relies on the market for retirement. These investment vehicles tend to be extremely volatile and could hurt you if you are on the wrong side of the trade. If you feel that options are right for you and you have educated yourself, I would still recommend that you use option selling strategies over buying strategies. At least when you sell an option, time works with you and not against you.
The bottom line here is do not be sucked in by the potential profits. You must educate yourself of the real risks and profitable potential of these investments. Failure to educate can result in significant losses. Using a conservative approach to options is recommended as they make a great income source as well. Options can be extremely conservative or extremely risky; it’s up to you which side you want to play.