Why do some people have more 'luck' when buying options than
Better yet, why do some people have better luck with stocks than
I believe a lot of that has to do with fully understanding how
Believe me, options are not rocket science. But there are a few
more things to consider than when buying a stock.
For example: Delta. This is the percentage the option will increase
or decrease in value in relation to the underlying price movement
of the stock. The delta gets bigger as it gets closer to being
in-the-money or goes further in-the-money. The delta gets smaller
as the option gets further out-of-the-money.
For example: let's say you bought an out-of-the-money option on
stock XYZ for $500 with 2 months of time until expiration. Let's
also say the option had a delta of .5, which means it'll move 50%
of the underlying stock's movement, or in other words, it'll move
50 cents for every $1 the stock moves.
Now let's say the stock goes down -$3. That option will likely
decrease by -$1.50. (50% of the $3 move.)
However, that option's delta will also now have fallen. Let's say
that option now has a delta of .40.
If that stock went back up $3, that option will now only have
increased by $1.20. (40% of $3 is $1.20.)
So the stock is essentially where it was when it started. But the
option that was worth $500 is now off by -$30 or -6% from its
original value when you bought it.
If that move happened over a course of weeks or more, the loss in
the option would likely be even greater as the option would have
experienced a larger amount of time decay.
Moreover, if the movement in the stock was slow and incremental
over time, volatility would likely have decreased as well in the
option, which means it would have reduced the delta even more, thus
limiting your ability to 'make it back'.
And if your option is fully out-of-the money -- since your option
has no intrinsic value but instead only time value, the less time
you have left on your option, the less value that option will have.
Getting back to our example, let's say that option now has only a
few weeks left until expiration and it's still out-of-the-money.
That option could literally be worth only $20 or $30 (or less) -
which is far from the $500 that you originally paid. And this is
true even if the stock stayed the same or was even higher than when
you bought the option.
And that's the point I want to make.
You cannot trade options solely based on the underlying stock.
If you buy a stock and it goes down, and then meanders about for a
while before going back to where you bought it, your gain or loss
is zero. You haven't made anything or lost anything. If you wanted
to sell it for what you bought it for, you could.
With options though, you have to look at the option's delta, as
well as the volatility (as this will impact the delta), and also
how much time you have left on the option before it expires.
The option traders who consistently lose are the ones who forget
about these simple things.
If you find yourself saying, "I might as well hang onto the option
since it's fallen this far and since I still have time", you'll
likely be the guy who turns a loss of
of his option premium into a loss of
of his option premium.
Now this article isn't meant to 'neg' anybody out on options. On
the contrary, it's meant to empower someone to take decisive action
and to cut their losses when the trade is not working out. Because
while options provide great leverage with a small amount of money
and a guaranteed limited risk - you do not have all the time in the
world as you do with as stock.
If what you were expecting to see happen isn't happening, cut your
losses and rethink your strategy before time runs out and you lose
what you put in.
Nothing will 'neg-out' a new options trader quicker than losing his
entire premium. And the way that happens is by not understanding an
option's limitations in addition to its advantages.
So pay attention to the option's delta, time value/decay and
volatility. And remember, when you're trading options, there's more
to winning in options than just the underlying stock movement.
You can learn more about different option strategies by downloading
our free options booklet: 3 Smart Ways to Make Money with Options
(Two of Which You Probably Never Heard About).
Just click here.
And be sure to check out our
Zacks Options Trader
Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
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