The other week one of the loyal readers of this blog (Rhys) commented and asked a few questions on my "what is options trading" post.
There are several answers to the questions, but I'll answer the questions according to my own experiences. Other experienced traders can leave their own perspective in the comment section if they so choose:
Point #1.) "I'm still not totally clear on why there would be any reason to trade options instead of stocks…"
Point #2.) "…If the stock's value is going to go up, why not just have the stock and sell it when you would have sold the option?"
People trade options for the following reasons...
I can't speak for all option traders, but I trade stock options because it provides a low cost way for me to participate in the same stock movement that regular stock traders are participating in. I'll give you an example of one of my option trades along with the hypothetical stock example.
Here is the stock equivalent of one of my option trades (excluding commissions). The figures are based off of the stocks closing price for the day:
1.) 1/27/09 bought 200 shares of Humana Inc. symbol "HUM" for $38.93/share (total cost basis $7,786 (38.93 *200))
2.) 2/10/09 sold 200 shares of HUM for $43.56, received $8,712
3.) Total profit: $926 or 11.8% return on my money
4.) Disregarding stop losses, I risked $7,786 to make $926
Here were the actual results of my option trade:
If you recall TG informed you that 1 option contract controls 100 shares of stock, it gives you the right to, buy or sell, 100 shares of a specific stock.
1.) On 1/27/09 I bought 2 stock option contracts of Humana Inc. (HUM) and paid $90 total for those 2 contracts (they were call options).
2.) I closed the trade roughly 15 days after I entered it (on 2/10/09). The options went up in value to $165. I bought two contracts so that means $330 ($165 *2) was put back into my account. Remember though, I only invested $90 on this trade. Let’s see how much money I made.
3.) $330 - $90 = $240 profit or 267% return on my money.
4.) Disregarding stop losses, I risked $90 to make $330.
This was a very high risk trade and I didn't want to commit $7,000+/- to the trade. So I spent $90 and walked away satisfied with the results. Returns like this don't happen often, but they do happen nonetheless. The purpose of the example was merely to show you why I bought the option instead of the stock.
Because it was cheaper, and I still was able to make a decent return on my money in a short period of time. Be careful though, with great returns come great risk.
And just to be clear this is not a recommendation to trade stock options. They are certainly not for everyone. The purpose of my last two posts was to give you a general overview of stock options. The posts were not meant to teach you how to trade stock options.
Others may disagree, but it will be hard to learn how to trade stock options by reading a few blog post here and there. I always recommend new traders find a competent mentor to teach them. TG has several that contribute to this blog on a daily basis.
Regards, Travis
http://www.pursuingwealth.com/
There are several answers to the questions, but I'll answer the questions according to my own experiences. Other experienced traders can leave their own perspective in the comment section if they so choose:
Point #1.) "I'm still not totally clear on why there would be any reason to trade options instead of stocks…"
Point #2.) "…If the stock's value is going to go up, why not just have the stock and sell it when you would have sold the option?"
People trade options for the following reasons...
- the leverage that they provide
- to get more bang for their buck
- to try to get rich quick (good luck with that)
- for their versatility (you can create trades specific to your needs)
- to trade covered calls
- because they are rather inexpensive compared to buying many shares of stock
- many, many, many, more
I can't speak for all option traders, but I trade stock options because it provides a low cost way for me to participate in the same stock movement that regular stock traders are participating in. I'll give you an example of one of my option trades along with the hypothetical stock example.
Here is the stock equivalent of one of my option trades (excluding commissions). The figures are based off of the stocks closing price for the day:
1.) 1/27/09 bought 200 shares of Humana Inc. symbol "HUM" for $38.93/share (total cost basis $7,786 (38.93 *200))
2.) 2/10/09 sold 200 shares of HUM for $43.56, received $8,712
3.) Total profit: $926 or 11.8% return on my money
4.) Disregarding stop losses, I risked $7,786 to make $926
Here were the actual results of my option trade:
If you recall TG informed you that 1 option contract controls 100 shares of stock, it gives you the right to, buy or sell, 100 shares of a specific stock.
1.) On 1/27/09 I bought 2 stock option contracts of Humana Inc. (HUM) and paid $90 total for those 2 contracts (they were call options).
2.) I closed the trade roughly 15 days after I entered it (on 2/10/09). The options went up in value to $165. I bought two contracts so that means $330 ($165 *2) was put back into my account. Remember though, I only invested $90 on this trade. Let’s see how much money I made.
3.) $330 - $90 = $240 profit or 267% return on my money.
4.) Disregarding stop losses, I risked $90 to make $330.
This was a very high risk trade and I didn't want to commit $7,000+/- to the trade. So I spent $90 and walked away satisfied with the results. Returns like this don't happen often, but they do happen nonetheless. The purpose of the example was merely to show you why I bought the option instead of the stock.
Because it was cheaper, and I still was able to make a decent return on my money in a short period of time. Be careful though, with great returns come great risk.
And just to be clear this is not a recommendation to trade stock options. They are certainly not for everyone. The purpose of my last two posts was to give you a general overview of stock options. The posts were not meant to teach you how to trade stock options.
Others may disagree, but it will be hard to learn how to trade stock options by reading a few blog post here and there. I always recommend new traders find a competent mentor to teach them. TG has several that contribute to this blog on a daily basis.
Regards, Travis
http://www.pursuingwealth.com/
1 Comments:
Travis,
I don't understand the "great risk". I think you only risked $90. Aren't options less risky than stocks?
Todd
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