Asked by Anonymous
Asked on 24 Mar 2019
Options may be a good way to invest money because of the high returns that it may generate. However, the saying goes "There is no free lunch in the world". It is worthy to note that options are highly leveraged derivatives (basically a derivative is something which value is reliant upon, or derived from, an underlying asset or group of assets).
Buying options allow you to control a greater amount of the underlying security, such as stocks, than you could by actually trading the stocks themselves. For instance, you have $1050 to invest and you wished to invest in Sheng Siong (which currently trades at $1.05 per share) because you believed it was going to increase in price and may purchase 1000 shares with your capital (assuming no transaction costs or commission).
If the stock went up in value, then you would be able to sell those shares for a profit. For example, if they went up by $0.50 to $1.55 then you could sell them at $0.50 profit per share for a total profit of $500 (not accounting for any commissions on your trades).
Now let’s assume you decided to invest in call options instead, trading at $0.30, with a strike price of $1.05. If the option contract size is 100 you could buy 35 contracts at $30 each: meaning you effectively have control over 3500 shares in Sheng Siong (35 contracts, each covering 100 shares). This would mean that using your $1050 to buy options has given you control of 3.5 times as many shares as using your $1050 to directly buy shares at $1.05. With the price of Sheng Siong going up to $1.55, you would make a lot more money through selling your options at a profit at lets say $0.50 per call option, which translates to a profit of 3500*(0.50 - 0.30) = $700, which is more than the $500 more that you would have made from buying the shares directly.
While leverage through options magnifies your upside, it increases your downside as well. For instance, in the circumstance that somehow there is a global recession/some freak incident that happens to Sheng Siong and its share price drops to $0.55 overnight, the losses you would sustain if you were to buy the shares directly would be (1000*0.50) = $500.
On the flipside if you have bought options instead they expire with Sheng Siong's share price at $0.55, the options could effectively be worth nothing. In short, when you buy options, there is a chance that you might potentially lose all your capital, as compared to approximately half your capital (in the case where you had bought the shares directly).
In short, it is not advisable if you are new to investing to buy options, since it is highly complex and risky. I've personally made gains (and losses) from buying options and if you are not down for an emotional roller coaster, it could be better to buy something that carries less risk!
Options are highly advanced instruments. If you are just starting off on investing, do not think of options as an alternative to stock/forex trading - learn the basics first- stocks or forex trading.
You need atleast some mathematics strength to really understand them. They're amplifiers - they can magnify gains and losses both!
There is no 'good' or 'bad' product - only less dangerous and more dangerous.
Another factor to consider is whether the time needed to trade fits into your lifestyle.
For me, as I am a day-person (morning lark), I prefer to trade Forex instead as I can trade it in the morning and the afternoon, for 30-60 minutes per trading day.
Trading US Options requires you to trade at night when the US stock exchanges are open (from 9.30pm or 10.30pm depending on daylight savings). It suits well for night-person (night owl).
Hopefully this can help you decide whether to trade Options or Forex, or even both.
If used and managed correctly, you can look at returns exceeding 30% or more using options. I deploy mainly bull put spreads in my portfolio, combined with some iron condors and straddles. Am targeting returns of 60% pa.
If you are new to options, you may wish to find a mentor to guide you. Options if used incorrectly can blow up your account and more (margin call).
I'd avoid buying options, as you need to be 100% right in your direction to make money. 80% or more of option positions expire worthless so selling options can be a better choice. You don't need to be 100% right to make money.
Do note that options are not available in SGX, mainly in the US market.