Who decided that options are too risky for the everyday investor? More importantly can somebody please explain why options are too risky? After years of research I have finally come to understand that there are 3 types of people that can be held responsible for the Myth that options are too risky. Who?

1. Financial Planners

2. Stock Brokers

3. Taxi Drivers

Is it possible for the uneducated investor to lose lots of money if they trade options? Yes of course they can, first of all the uneducated investor can lose tons of money using any trading instrument and secondly options are highly leveraged so if used incorrectly then they will increase your losses. So if this is the case then why an I saying that trading stock options isn’t risky?

The first thing that you must realize about stock options is that they were actually invested to reduce or manage risk. The whole idea of buying a put option to hedge you stocks is basically another form of insurance. When looking at your portfolio risk management options buying puts to ‘insure’ your stocks is one of the most conservative investment strategies that you can implement.

On the other hand selling call options on stocks that you already own (covered calls) is another incredibly conservative stock market strategy. This strategy actually increases your downside protection, so when used correctly the myth that options are too risky is simply not true. Of course if you start writing naked calls or naked puts then your risk levels are going to seriously increase but when used correctly options are an amazing risk reduction tool.

Let’s have a look at why financial planners, Stock Brokers, and Taxi drivers are giving Options such a bad name.

Financial Planners: If you go to your financial planner and say that you would like to include options in your trading strategies then they will almost definitely tell you that it is a very bad and risky idea. Why? Simply because 99% of financial planners wouldn’t have a clue how to use them. I recently spoke to a financial advisor who admitted that her entire financial planning degree only had one chapter on options and it was completely theoretical information. In their entire course there was not one bit of practical information about how to use options. So considering that most financial planners don’t actually know what stock options are let alone how to use them is it any wonder that their typical response is negative. Remember human’s beings fear change and looking stupid.

Stock Brokers: Surely Stock brokers don’t think that options are too risky? Aren’t they meant to be professional stock market investors? Unfortunately most stock brokers are exactly that ‘STOCK’ brokers not ‘OPTION’ brokers. To become a legal options broker there are additional courses that you need to complete so most stock brokers aren’t actually allowed to give you ‘option’ advice. Put yourself in their shoes for a minute - if a client came to you and said “What do you think of buying Options” then you are faced with two choices

1.Tell them that is a great idea but unfortunately you will need to take all of your money out of our accounts and go to another broker who is legally allowed to trade options, Good Luck with your investing.

2.Or you could tell them that options are too risky and you really should just stick to managed funds and stocks.

So what answer would you choose?

Taxi Drivers: Obviously this is a little bit of a joke but the point I am trying to make is that everybody seems to think that trading stock options is too risky. It is extremely important to remember to make up your own mind about investment strategies, whatever you do don’t take advice from a taxi driver about wealth creation.

“the most expensive advice you will ever get is free from poor people” Kurek Ashley

So are Options too risky? If used incorrectly yes but perhaps the question you should ask yourself first is ‘what are stock options’? Before you dismiss something as being too risky or scary make sure you try to understand what it actually is and how it works. There are plenty of free resources on the internet so do some research and make up your own mind about stock options. The last thing you want to do is ignore something just because that is what everybody else thinks. After all are these people achieving the results you are after or are they still driving taxis?



By: Banjo Smyth

About the Author:

A credit spread is a type of vertical spread. It is a trading strategy in which you are buying an option, call or put, at a certain strike price, and simultaneously selling the same type of option at a different strike price of the same month. The sold strike price must have a higher value thus creating a credit at the time the trade is placed. As time goes on the options premium will depreciate, and as long as the price of the stock does not go past the sold strike price at the end of expiration, you keep the full credit. There are two main ways to trade credit spreads - either a low capital risk trade or a high probability trade.

The low capital risk trade consists of making a trade using in the money (ITM) options or at the money (ATM) options to compose the credit spread. For example a stock trading at $55. You are bearish on this stock feeling that it will fall below $50 and stay there. You create a credit spread using calls called a Bear Call Spread. You would sell an ITM $50 call for $5.75 and then buy an ATM $55 call for $2.00 creating a credit for $3.75. The max value of the spread, the difference between strikes, is $5 (55-50), which makes your max risk is $1.25 (5-3.75). This is the low capital risk your are making $3.75 while risking $1.25 which makes for a 300% rate of return. So a high rate of return a low capital risk, what could be wrong with this trade? The probability of success. The stock needs to be below $50 and stay below $50 at the expiration of the options in order to be a successful trade. You need to be correct in your assessment of the direction of the trade.

The high probability trade consists of making a trade using out of the money (OTM) options to compose the credit. Using the same example of a stock trading at $55 that you are bearish, feeling it will fall and stay below $50, we create a different type of credit spread. To create the credit spread, you would sell an OTM $65 Call for $1.10 and buy an OTM $70 Call for $.50 creating a credit of $.60. The max value is still $5 which makes your risk $4.40, much higher than the previous example. This makes for a high capital risk making only $0.60 while risking $4.40 which makes for a 13% rate of return. The difference however is in the probability of the trade being successful. The stock will need to close below $60 at expiration of the options and since it already is below $60 and you feel the stock is weak and will be going lower. The probability of it gaining 10 points or 18% is unlikely in comparison to the previous low capital risk trade in which the stock is at 55 and has to fall 5 points and stay below $50 for the trade to be successful, which makes this credit spread a high probability of success.

Low capital risk but also a low probability of success for the beginner or a higher capital risk with a high probability of success makes for the two choices for the credit spread trader. The choice depends on the traders personality a more involved trader one that really likes to pay close attention to his trade and can make adjustments when necessary may prefer the low capital risk trade. The trader trading part time or is more conservative in their trades one that likes to place a trade and then just monitor it once daily would be more likely to choose the high probability trade. Which type of trader are you?



By: Dan Beatty

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