Make sure you’re aware of these option concepts before trading them.
Options are a zero-sum game. You don’t own the underlying, so you don’t receive dividends from a business or interest payments from a debtor. In order for you to make money, the counterparty must lose. Keep in mind that you are speculating against highly sophisticated market makers and other market participants that don’t like to lose money. You have to have a strong edge to beat these opponents.
Options are used to speculate against volatility levels as well as the direction of the underlying. If you’re unsure of how volatility plays out in the market don’t attempt to trade options. You will lose.
Options allow you to make a leveraged bet on the direction of underlying stocks. This leverage can create incredible returns, but at the same time has the ability to bankrupt your account.
If you are using the option as a directional bet you need to have an edge in the underlying to win, the option itself won’t add any value to the trade. It can actually take away value from the trade if you are overpaying from a volatility perspective.
Finally, options are costly to trade. Commissions add up and the bid ask spread is wide — both of these costs will eat into your P&L and this cost increases significantly if you trade options on small timeframes.
To learn more, make sure you watch the video above!
And as always, stay Fallible out there investors!