Give it to me straight: the advantages and disadvantages of options?

Martinghoul said:
What is an option? What determines the payoff of the option? What are the two parts that option value consists of?

To be honest, I really don't understand what this 'majority of options expire worthless' adage means. As to theta (aka time decay), it's, by definition, a fair price to pay for being long the volatility arnd expiry. Bid/offer on multi-leg strategies is a fair point, which is why properly trading options in a retail environment is difficult.
I am talking about exercising European options which is what NRoth was describing. Selling/buying the options in the mkt can, in fact, be done any time.
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As I said, it's been ten years and I'm a bit rusty.

Any option that has a strike price expiring above the share price must expire worthless.
The others will have some value. As you say, what category the "majority" falls into, I do not know but, whatever happens, unless the share takes off in a massive manner, something like a takeover bid, most options lose considerable value by the time of expiry.

Options are meant for serious students, not those thinking for a quick profit. Most of those are like normal punters, they hang on too long and worse, they buy calls precisely when time decay starts to set in.

I got confused with the words "exercise" and "trading". Sorry.

Regards Split
 
Splitlink said:
Any option that has a strike price expiring above the share price must expire worthless.
The others will have some value. As you say, what category the "majority" falls into, I do not know but, whatever happens, unless the share takes off in a massive manner, something like a takeover bid, most options lose considerable value by the time of expiry.
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Yes, any option that expires out of the money expires worthless, as in your description of a call... But what exactly does that tell you about the viability of trading options?

For example, what if we assume that most options in the mkt are bought by real money investors as part of 'calamity protection' strategies, effectively as insurance for their large outright portfolios? In that case, most options bought are far out of the money (OTM) to begin with and will expire that way. Does that mean that the specific options you buy will expire worthless? Not at all, as it will depend on what sorts of options you buy.

The fundamental point you have to remember about trading options is that, unlike trading the underlying instrument, it's not just about direction, but about direction AND speed. It's not sufficient to just get the long/short bit right; you also have to be right on how fast the price will rise/fall. Any option trade, therefore, incorporates both views.
 
But would not the large portfolio investor write out of the money options with a view to collecting the option money and not having to buy back the share later? He is, in fact, calculating that his option will expire worthless. This is the risk that the buyer takes. If he gets a call on his shares he is, still, going to sell at an exercise price that exceeds what he paid for the share. I assune that he worked that out before he started.

The fundamental point that you mention is absolutely correct and means that option trading is not for most people, but is highly specialised.
 
OptionsMike said:
Selling far out of the money options can produce very high win rates and periodic income. For more information visit this educational website: http://www.safe-options-trading-income.com/
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Can also lead to unlimited losses......

There is a real danger in selling out of the money options, because as soon as one of those options starts getting into the money their volatility premium shoots up which puts you in huge unrealised losses, well inside the profitable range of the option when it expires. I would strongly advise against this sort of trading on its own as there are no real exit strategies without losing many times more than the premiums you recieve.

I spreadbet options quite heavily on IG. They are a very useful tool to those that understand their nuances. I use them to trade volatility (lack of as well as lots of) which suits me fine as I don't need to predict the direction of the markets to make money.
 
Never buy an option as its value will errode.
Best is to sell calls or puts.
What hoggums is doing is very wise, what he can do is make a judgement that the market is heaing for a rise/fall and take the relitive action with an option.
If he were to use futures he could get stopped out or incourr high margin requirements.
All though the return of trading options this way dose not give as much return as futures the risk if loosing is much lower.
Think about how many times you were right about the markets and your timming was slightly wrong resulting in a loss ?
What hoggums dose is he takes the options and lets them ride untill the postion geneates cash.
However his timming has to be right, but a day or two of him been early will not cost him dearly and he is still in the market when the direction goes his way.
Remember he will use futures intra day aswell as a hedging stratogy.
If he is clever ( no dought he his ) its heads he wins and tails he wins.
He will have to be extreamly unfourtunate to occour a loss by using this type of stratogy.
Best of Luck to him and all who use's such stratogies, it really is the way to go in this business.
TomTom
 
I am with gooseman here... This is the most misguided blurbage about options I have heard.
 
essentially what i ahve heard on this thread is:

don't buy options because they decay.
sell options because they decay.

don't worry about delta on out the money strikes if you're short.
 
gooseman said:
essentially what i ahve heard on this thread is:

don't buy options because they decay.
sell options because they decay.

don't worry about delta on out the money strikes if you're short.
Click to expand...
Moreover, don't worry about the mark-to-mkt/margin issues (a la AIG) when wing vol explodes as everyone scrambles to cover...

Don't get me wrong, I am not saying selling options is necessarily evil. I'm just saying that there seem to be lots of people out there that don't quite appreciate the meaning of 'negative convexity'.
 
If you would care to spend more than 5 minutes learning about options then there is some very good FREE education including webinars here:
http://www.ise.com/
Click on the tab on the left that says education.
Option trading brokers like ThinkorSwim or OptionsXpress also have good education areas and allow you to papertrade options on demo.
This conversation/thread might then be a little more useful to you.
 
Hoggums said:
Can also lead to unlimited losses......

There is a real danger in selling out of the money options, because as soon as one of those options starts getting into the money their volatility premium shoots up which puts you in huge unrealised losses, well inside the profitable range of the option when it expires. I would strongly advise against this sort of trading on its own as there are no real exit strategies without losing many times more than the premiums you recieve.

I spreadbet options quite heavily on IG. They are a very useful tool to those that understand their nuances. I use them to trade volatility (lack of as well as lots of) which suits me fine as I don't need to predict the direction of the markets to make money.
Click to expand...


But equally, if you BUY out of the money options (particularly deep otm, 'lottery ticket' trades), you fall victim to two factors, potentially even three, i.e. spread, smile, and sometimes (but not always) skew, that make it a cast iron certainty that you are paying over the odds for them.

The problem with that is that it turns the trading of these things, unless you're the guy who hits a home run being short S+Ps in 1987 or whatever, into a death by a thousand cuts. You're backing a horse at 10-1 whose likelyhood of coming in is realistically nearer 15-1 etc etc. I.e. compared to what the theoretical models say it's worth (black scholes, binomial, vanna / volga or whatever, depending on what you're trading), you're paying too much, and so on average you're always gonna lose in the long run.

While that will hold true for someone trading options as an outright, effectively leveraged directional bet, it sure goes double for the person who is just gonna buy protection options against ALL their positions. These are positions you're putting on because you are reasonably confident, for example, that eurusd is gonna go UP (so you buy puts as protection against your long possie). So, if you have any sort of a winning edge in your spot choices, by definition your options are usually gonna take a bath.

Make sense? Not a reason not to trade opts, but it's why the pros, when they trade options, do it a very different way.

My $0.02

GJ
 
yup-alot of guys trading options as primary income are simply trading gamma (short dated vol)
 
Or even if they're expressing a directional view, they won't necessarily just buy naked options. Plus they'll finagle strikes, dates etc to look for where the value is in the curve. It's just a lot more involved than trading cash.

GJ
 
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