If there is "little to no obligation" with option trading, then what is the drawback?

Question

The draw backs or pros vs. cons of option trading?

Answer 1

Option trading is very dangerous for a naive investor. Take some time to understand the mechanics and obligations of option trading.

Even hardened investment professionals avoid derivatives trading when they can.

Answer 2

<<<If there is "little to no obligation" with option trading, then what is the drawback?>>>

I don't know where you heard there is "little to no obligation" with option trading, but it sounds like something that a sleazy salesman would way. At best it is a distortion of the truth.

If by option trading you simply mean buying options and later selling them, your obligation is the same as it is with stocks. You pay money to buy them, the entire amount you pay is at risk, and sometimes you can sell what you purchased for a profit. The major difference is that it is a lot easier to lose your entire investment with options.

If you write options instead of buying them you are, by definition, accepting a large obligation. Hence I will assume that is not what is meant.

<<<The draw backs or pros vs. cons of option trading?>>>

Pros:

If you have learned enough, you can control the amount of risk you take.

You can make money either by movement in the stock price or by changes in the implied volatility of the option.

There are multiple strategies available, so you can choose a strategy that matches your outlook.

Cons:

You can lose money either by movement in the stock price or by changes in the implied volatility of the option.

Options are more complex than stocks. To an option trader a stock has one kind of risk, known as delta risk. An option has delta risk, gamma risk, vega risk, theta risk and rho risk.

Options are a zero-sum investment. For every dollar one person makes on an option someone else loses a dollar. Much of the trading is done by professionals and when you start you will be an amateur. Who do you think is more likely to make a dollar?

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I am not trying to say you should not trade options. I am simply saying if you want to trade them you need to prepare first by reading at least one good book on options and paper-trading before investing real money.

Answer 3

The draw back in option trading is selling PUT's or CALL's without owning the stock and having the stock put to you are called away from you in the event that the stock price closes at or above  the strike price at expiration 'in the money'. You then have to cover that position, either with the stock or putting up the cash to buy the stock at that strike price.

The pro: is selling the option, collecting the premium and keeping the premium if the stock closes below the strike price 'out of the money'.

If you buy a PUT and the stock price goes down, the strike price increases and you can the sell it back to the market before expiration and profit on that gain in the strike price. If you sell a PUT and the stock price goes up, again the strike price goes down in value. You can then buy it back at a lower price and profit from the difference in the strike price.

If you buy a CALL and the price of the stock goes up, the price of the option also goes up. You can then sell it back to the market at a higher price and profit from the defense in the strike price.

con: If you sell a CALL and the price of the stock goes up and is at the strike price on or before expiration you risk being called out on that option. Same thing with selling PUTs. If the stock hits the strike price on or before expiration, the option may be put to you in which case you have to relinquish the 100 shares of stock or by them and relinquish the stock.

This is only a partial explanation of option trading in it's simplest form. There are dozens of way to trade options but if the stock closes at the strike price on a CALL or PUT and don't own the stock or the money to put up for the purchase of the stock in the event it's put to you or called away from you, you're in deep sh*t, dutch, trouble!

If you sell naked positions you really don't want the stock to move much at all. On the other hand, if your buying a CALL or PUT you want a huge move in the stock to collect a profit.

There are other factors involved like volatility, time value and time decay but like I said, this is a simple and basic explanation of a few ways to trade options. It is only risky 'IF' you don't own 100 shares of the stock for the contract if your selling naked positions.

Investools offers a free 2hr. seminar where they will briefly go into option trading but it will give you a gist of what it's all about.

http://www.investools.com