SteadyOptions is an options trading forum where you can find solutions from top options traders. Join Us!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Pros And Cons Of Options Trading: Advantages & Disadvantages


Options trading has many advantages over stock investment. They are flexible, can be used to manage risk and are capital efficient. But there are also several key disadvantages. Here's our guide to the pros and cons of options trading.

 

 

pros and cons of options trading

What Are Options?

Options are contracts that allow an investor the option to purchase or sell stock at a particular price anytime before it expires.

 

An option contract generally covers 100 shares of the company; so, if you buy the right to buy Apple stock at a certain price, it is for 100 shares of the company.

 

Keep in mind that these contracts are distinct from the stock options employees may receive from their respective employers.

 

Call Options

If you buy a call option, you're buying the right to purchase at a certain price (the strike price) by a preset expiration date, although there is no obligation to do so.

 

When you sell a call option, you are agreeing to sell the stock at that price if the buyer assigns (or takes up) their option.

 

Put Options

Put options are a type of financial instrument that give the buyer the right, but not the obligation, to sell a stock at a specific price within a set timeframe.

 

Pros Of Options Trading

Options have the following advantages to a trader:

 

Limited Downside (For Buyers)

An option buyer can only lose the value of the bought premium (unlike sellers - see below).

 

(However, this is unlike owning stock where losing everything is rare).

 

Smaller Commitment

Options allow you to benefit from stock price movements without having to buy actual shares. Consequently, your potential returns could be much higher compared to what you initially put in. If things don't go your way, you're only out the contract premium.

 

Flexible strategies

Many more investment strategy can be achieved trading options than with stocks.

 

Depending on the type of option and whether you are the buyer or seller, options can be used to protect existing investments, provide supplemental income from existing stocks, or meet other investment objectives.

 

For example of you're bullish about a stock - you expect it to rise - you can use a long call or bull call spread to take advantage of any increase in stock price.

 

Similarly bears can trade long puts or bear put spreads.

 

Options can even be used if you believe a stock won't move much: options trading strategies such as calendar spreads and iron condors be traded profitably.

 

Cons Of Options Trading

However options do have several disadvantages

 

Complexity:

You must comprehend the technical language and regulations associated with options.

 

Therefore, it would be advisable to stay away from them until after you have obtained a decent amount of expertise in the stock market and have studied their operation.

 

Options sellers' risk is potentially unlimited

For example the seller of a call option with a $200 strike price is obliged to sell shares at this price at any time during the option's life.

 

But the share could potentially rise to any price forcing a trader to buy at this price but sell for the $200. The potential loss is therefore (in theory) infinite (although this can be mitigated by proper risk management).

 

Low Liquidity

Lower liquidity of some stock options can be a major challenge for traders looking to enter and exit the trade market.

 

Options Margin requirements can run up trading costs

One of the biggest costs associated with options trading is margin requirements, the amount of money that must be deposited with your brokerage in order to open an options position.

 

The amount of margin required depends on the type of option being traded, as well as the underlying security.

 

Commission Costs

Options trading costs more expensive as compared to future or stock trading, especially with a full-service brokerage.

 

You may be able to reduce these costs using discount brokers such as Robinhood to trade on lower commissions.

 

Bottom Line

When analyzing the pros and cons of option trading, there are many factors to consider.

 

The safety net of defining your downside allows you to speculate on short-term price movements while still preserving all of the upside. Moreover, buying options has a positive skew. In statistical terms, this means you’ll lose a small amount of money most of the time and make a large amount of money some of the time.

 

The trade-off is extremely beneficial because you only need a small number of trades to pay off to have a profitable month or year.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

Join SteadyOptions Now!

 

What Is SteadyOptions?

12 Years CAGR of 129.0%

Full Trading Plan

Complete Portfolio Approach

Real-time trade sharing: entry, exit, and adjustments

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Subscribe to SteadyOptions now and experience the full power of options trading!
Subscribe

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • The 7 Most Popular Cryptocurrencies Right Now

    There are thought to be 20,000 cryptocurrencies currently in existence. While a lot of these are inactive or discontinued, a lot of them are still being traded on a daily basis. But just which cryptocurrencies are most popular? This post takes a look at the top 7 most traded cryptocurrencies.

    By Kim,

    • 0 comments
    • 3,037 views
  • Harnessing Monte Carlo Simulations for Options Trading: A Strategic Approach

    In the world of options trading, one of the greatest challenges is determining future price ranges with enough accuracy to structure profitable trades. One method traders can leverage to enhance these predictions is Monte Carlo simulations, a powerful statistical tool that allows for the projection of a stock or ETF's future price distribution based on historical data.

    By Romuald,

    • 10 comments
    • 7,514 views
  • Is There Such A Thing As Risk-Management Within Crypto Trading?

    Any trader looking to build reliable long-term wealth is best off avoiding cryptocurrency. At least, this is a message that the experts have been touting since crypto entered the trading sphere and, in many ways, they aren’t wrong. The volatile nature of cryptocurrencies alone places them very much in the red danger zone of high-risk investments.

    By Kim,

    • 0 comments
    • 2,816 views
  • Is There A ‘Free Lunch’ In Options?

     

    In olden times, alchemists would search for the philosopher’s stone, the material that would turn other materials into gold. Option traders likewise sometimes overtly, sometimes secretly hope to find something which is even sweeter than being able to play video games for money with Moincoins, that most elusive of all option positions: the risk free trade with guaranteed positive outcome.

    By TrustyJules,

    • 1 comment
    • 17,686 views
  • What Are Covered Calls And How Do They Work?

    A covered call is an options trading strategy where an investor holds a long position in an asset (most usually an equity) and sells call options on that same asset. This strategy can generate additional income from the premium received for selling the call options.

    By Kim,

    • 0 comments
    • 3,044 views
  • SPX Options vs. SPY Options: Which Should I Trade?

    Trading options on the S&P 500 is a popular way to make money on the index. There are several ways traders use this index, but two of the most popular are to trade options on SPX or SPY. One key difference between the two is that SPX options are based on the index, while SPY options are based on an exchange-traded fund (ETF) that tracks the index.

    By Mark Wolfinger,

    • 0 comments
    • 7,671 views
  • Yes, We Are Playing Not to Lose!

    There are many trading quotes from different traders/investors, but this one is one of my favorites: “In trading/investing it's not about how much you make, but how much you don't lose" - Bernard Baruch. At SteadyOptions, this has been one of our major goals in the last 12 years.

    By Kim,

    • 0 comments
    • 4,384 views
  • The Impact of Implied Volatility (IV) on Popular Options Trades

    You’ll often read that a given option trade is either vega positive (meaning that IV rising will help it and IV falling will hurt it) or vega negative (meaning IV falling will help and IV rising will hurt).   However, in fact many popular options spreads can be either vega positive or vega negative depending where where the stock price is relative to the spread strikes.  

    By Yowster,

    • 0 comments
    • 6,828 views
  • Please Follow Me Inside The Insiders

    The greatest joy in investing in options is when you are right on direction. It’s really hard to beat any return that is based on a correct options bet on the direction of a stock, which is why we spend much of our time poring over charts, historical analysis, Elliot waves, RSI and what not.

    By TrustyJules,

    • 0 comments
    • 3,960 views
  • Trading Earnings With Ratio Spread

    A 1x2 ratio spread with call options is created by selling one lower-strike call and buying two higher-strike calls. This strategy can be established for either a net credit or for a net debit, depending on the time to expiration, the percentage distance between the strike prices and the level of volatility.

    By TrustyJules,

    • 0 comments
    • 5,113 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs