In all the time that I have been investing in the stock market, both as an individual investor and as a future retiree, I've never invested in stock options. However, in the world of stimulus checks, these have become more and more popular and even more so in the world of meme stocks like Gamestop GME.
What is an Option
In my brokerage account I had to first ask for permission to trade options. Presumably, this was to ensure that I had enough money and I understood that there were risks that were not clearly understood to the average stock market investor. Indeed, in some cases your losses could be severe -- much more severe than in the case that you actually bought a stock.
Put simply, a put option is a bet the price of a stock will go down. A call option is a bet the price will rise. On a stock that is at 100, you could buy a put at a strike price of 90. That means, you're betting that the price will drop below 90 dollars, and the put option gives you the right to sell the stock at 90. So, if the stock drops to 80, the option means that you can sell the stock back to the owner at a price lower than it is trading for. That is, 10 bucks.
A call option is the same process in reverse.
For options, there is something called an option chain.
An option chain is a series of dates and call/put options for strike prices around which the stock is currently trading. Depending on the volatility, the strike prices may be 1 or more dollars apart. What is nice about this is that you're able to select a variety of dates and strike prices to suit what you expect that the stock will do.
My Experience
While all of this sounds good on paper, it is definitely riskier than buying the underlying stock. If I buy a stock for 100 bucks, especially if I think it is a good stock, the losses are typically some percentage of the value. Whereas for options, if they are not exercised, they expire worthless. The loss is 100 percent. Also, whereas most stock trades can be made at low or zero cost, options trades still charge a fee on my broker.
So, this month I bought two cheap options contracts for a few dollars, really just to get the experience. However, they both expired worthless.
In short, for the average investor, I really don't recommend options. They might be great for traders and people who have really strong convictions about the stock in question, but for average investors, even if you feel like something is going to positively or negatively impact a stock, the timing is difficult. And, the amount is also difficult. With options, you have to be right on everything AND you have to make sure that the trade actually makes money if everything falls correctly.
Since options cost something, the cost of the option might be more than you'd make if everything fell the way you expect.
I found investopedia to be a great resource when learning more about options.
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