Trading options is riskier than owning stocks. If you can’t afford to buy Google stock at $500 per share, purchasing Google options at $5,000 likely won’t be any easier. This is because options are bought in sets of 100, so even a single option priced at $50 ends up costing you $5,000 for 100 shares. Be cautious of seemingly cheap options for expensive stocks, as they may be close to their expiration date. For instance, I recently saw a Google call option for $2.00 that expired in just 14 days. If you don’t make a profit in that short time, you could lose your entire investment.
Important Points to Keep in Mind:
Options trading is complicated and not suitable for beginners. Even experienced hedge fund managers can suffer significant losses from trading options. Brokerages won’t let you trade options until you can prove you have over a year of trading experience.
Many options traders don’t make money. Trading software companies often lure customers with claims of high prediction accuracy, but these don’t necessarily translate to profits. Timing is crucial in options trading; even a day’s delay can cause substantial losses. To gauge the success of a trading strategy, you need to know clients’ annualized gains over time, information that is usually undisclosed. Statistics show that less than 2% of options traders actually profit.
Always check track records carefully. Financial advisors and companies may quote cumulative gains, which should be divided by the number of years to find the annualized return. For example, a 50% gain over twenty years is just a 2.5% annual return, which is not very impressive compared to lower-risk Treasury bills.
Options trading gives you a limited window to make a profit. Once an option expires, if you haven’t made money, you could lose your entire investment.
In summary, you’ll come across many sales pitches promoting options as an easy way to get rich or protect your finances. In reality, the software provider and salesman often benefit the most when options are sold to inexperienced investors. Be cautious of promises of quick wealth from investments in gold, oil, gas, or commodities like corn, cotton, or pork bellies.