Opening Position by Jayanthi Gopalakrishnan
ROY, how did you get interested in trading and in options in particular?
I was first exposed to options about 20 years ago when I read an options book titled Sure-Thing Option Trading by George Angell. At the time, I did not understand everything the author was trying to explain; however, it was clear to me that options were very powerful trading tools, and I became interested in learning about them. Then about 10 years ago, while securing my Mba, I actively started learning how to trade them. I started taking option trading classes, reading books about options, and trading options. That is how it all started.
Sounds like you are well versed in the topic. So why should somebody trade options?
Actually, there are many reasons. First of all, options give you the ability to manage your portfolio downside risk. Meaning it allows you to limit risk in the underlying position, while potentially receiving option premium credit at the same time. Second, a trader can trade options as a surrogate for trading the underlying asset. For example, you could trade option positions in lieu of buying the actual underlying stock.
When it comes to trading options, you can pretty much figure out what your return could be before you place your trade. But many people tend to lose a lot of money on options. Why is that?
Let me preface my answer by stating that trading options can be very risky if not properly understood and managed, and they are not suitable for all investors. However, in my opinion, traders can lose money trading any instrument. You can find more information about the risks of trading options by reading the options disclosure document, which can be downloaded from the Options Clearing Corp.’s website, located at www.theocc.com.
Now to answer your question, trading options is akin to playing a game of chess, and to play chess successfully, you need some education. Once a trader understands the mechanics of options, options will no longer seem as risky but will be viewed as a useful tool in a trader’s arsenal.
Why would somebody trade the option as opposed to the underlying? How would that benefit them?
The first thing that comes to mind is the actual capital outlay. You can trade option spreads at a lower cost than you would have if you were to purchase the underlying asset. For example, if you want to purchase shares of Apple, Inc. (Aapl), currently trading around $320, it will require a capital outlay of $32,000 for 100 shares. To many people, this is a significant portion of their trading portfolio. Alternately, a trader could use a small portion of that capital and trade options and still capitalize on a move in AAPL.