3 Advantages and Disadvantages of Options Trading
Everyone wants to look for a trading instrument that will give them the highest rate of return on their investment with as little risk, and little work as possible. While there may be misconceptions about options, (that they are a risky trading strategy for example) they do have both advantages and disadvantages. Every trading instrument will have its own personality, its own strategy for trading, but at the end of the day I think there are way more advantages that out weigh the disadvantages of trading options. Nevertheless, here are some things to consider when trading options.
Disadvantage – The Language
The language of options trading can be probably the biggest barrier to enter. There are many terms that a new trader would need to learn in order to feel comfortable in this market. Terms like ‘delta, call, put, at the money,’ etc. are just a few terms that probably don’t make too much sense for the average investor. And to make matters worse, in options trading each broker might use a different term to define the same thing. For example, a put credit spread and bull put spread are the same strategy, but referred to differently by different brokers.
Disadvantage: Options will expire
At the end of the life of the option, it will expire. At this point as a trader you will have a few options for the trade. You can exit the trade for a profit or loss, take assignment of the stock if your options is in the money, or roll the trade to a future expiry. So while time is something that an options trader can leverage by trading options that will expire a few weeks or months away, when time does run out, you can be stuck with an option that hasn’t made you any money, and this option may be worthless. One of the most popular questions I get asked in the trading room at Shecantrade About Shecantrade is; “ how do you decide what expiry to use when you trade?”. This is a very important question since the option you are trading is made up of both intrinsic value and premium. There will be times, when you trade options, that you may be correct about the direction of the underlying, but you ran out of time. Sure there are ways you can adjust trades to help boost your time value or adjust your trades if the trade has moved to a losing position, but again the value of time will be a big factor in the trade. Unlike stocks, where you can hold the trade without worrying it will expire, the options trader is generally risking less by trading the option versus the stock, but the options trader needs to have more variables line up in their favor to have a winning trade.
Disadvantage: Too Many Choices
While the flexibility of options is nice because of the amount of choices you have, it can also be a disadvantage as this can lead to the feeling of analysis paralysis. There will be times when you look at the market, and wont know which trade strategy to trade because there are too many ways to trade, too many ways to tweak the risk/reward, and too many factors to consider. Options can feel overwhelming. I’ve listed this as both an advantage and disadvantage, because depending on how you look at it, choice can be good, but too much choice can be bad.
Advantage - Time To Trade
I believe that Options are a great way to trade especially if you do not have all day to devote to watching the markets. Unlike a buy and hold strategy, options provides ways to trade by placing a spread outside of where a trader believes the price of the stock will be at expiry, this is referred to as trading out of the money. For this options strategy, a Trader places a trade outside of where they believe the option price will actually move, in turn, they may make less money per trade, but the probabilities of success are higher and they may not have to monitor the trade as closely as a more aggressive trade set up.
Time is on your side when you trade options. Options also provide the ability to trade based on the length of time you choose. An options trader has the flexibility to choose between options traded using a contract that will expire in different time frames, by trading monthly or weekly contracts. This flexibility in time may also mean that if a trader has more time to spend at the computer one week, they may place more weekly trades that need more monitoring while also placing some longer time frame trades that need less monitoring. The profits from each of these trades will be different, but may also balance out some of the risk in a trading plan.
Advantage: You can trade any in market direction
The best part about options is that you can use trade set ups for whatever way the market is moving. When the markets are consolidating Listen to the SCT Podcast Here you can trade in ways to trade advantage of premium, including spread strategies like Selling Iron Condors, Credit Spreads, and selling Straddles. When the markets are making big moves, you can trade strategies like buying calls, puts, and buying straddles. Regardless of markets that are trending, or transitioning, you can take advantage of the moves you are seeing with the trade set ups you already know.
Advantage: Predefined Risk
Most options strategies allow the trader to know their maximum risk at when they place their trade. The pre defined risk/reward offers a huge advantage for Options traders versus other types of trading because the unknown of profit loss and gain is removed. When you enter your trade, by buying and selling an option (or a combination of both) in a spread trade, you are able to take the worry of a potential loss away and tailor your risk tolerance by adjusting the width of the strike, and the value of the strikes you are trading (just to name a few examples).
The many options with options can be overwhelming if you are new to trading, but once you are familiar with the basics of options trading, the variety of trade set ups provides many opportunities to find trades based on a risk/reward that you are comfortable with. The flexibility of options can really work as an advantage for the trader who appreciates the ability to find multiple ways to trade.
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