Could I ever lose more than I put in when trading options?
I'm interested in trading options through my brokerage. I had a few questions regarding the information I've read from this site. If I decide to purchase a call option on company xyz and the trade went south, I would be limited in my loss so that what ever amount of money I paid (premium plus commission), would be the loss, is that correct? At any point in time, would my loss be greater then the money paid?
I am going to start out with a word of caution. Option trading can be very dangerous and volatile. You need to know what direction the underlying asset would move in and when it will move in that direction. You also need to know how much the asset would move in that direction. The value of the option also moves based on the volatility in the market. Unlike investing in stocks, where you have unlimited time to recover your losses, in option investing, time is against you and every minute that passes by, you are losing value if the asset does not move in the direction of your trade.So please be very careful trading options. I would suggest starting out with paper trading so you understand how option trades behave versus stock trading.
Now back to your question, if you are only buying calls and puts to open, then you are correct, you cannot lose more than the funds invested in the trade plus commission. But if you are writing call and puts without owning the underlying stock ( also called writing naked call & puts ), then you can lose a lot more than the initial investment in the trade. Good news is that your broker will probably not let you do naked calls and puts unless you have a considerable amount of margin available in your account.
Hope this helps and good luck with your trading!
With an option purchased, you cannot lose more than the cost of the option, plus your commissions paid. Keep in mind that 90% or more of all options expire worthless. Not only do you have to be right about the direction the stock is going, but you have to be right about the timeframe in which it will do so, and the price has to move enough to exceed your strike price by more than that price PLUS the cost of the option.
Please start small and get experience on your side before committing large amounts to your options trades.
Trading options is a sophisticated investment strategy and can be extremely risky. There are many complex strategies, but I'll try to keep it simple. Basically, there are two types of options: calls and puts. Buying calls allow you to purchase an underlying security at a specific price within a specific time period. Buying puts allow you to sell an underlying security at a specific price within a specific time period. So when buying options, you would buy calls if you were bullish and puts if you were bearish. If you're wrong and the trades goes against you, your loss is limited to the amount of money you paid for that call or put. You can always exercise your option and buy or sell the security before it actually expires, but that depends on your particular situation.
But for every option trade, like stock trades, there has to be a buyer and a seller. Selling calls and puts is where the risk comes in. If you sell a call, then you're obligated to sell the underlying security at the specified price if the buyer of the call decides to exercise the option and buy the security. What if the market has gone up since you sold that call? Well, you'll have to go into the market and buy the stock at a higher price in order to deliver and sell the stock at a lower price to the call buyer. Essentially, you're buying high and selling low and that is always a losing strategy. Because the upward movement of a stock is unlimited, your loss potential could also be unlimited. If the market goes down and the call you sold expires, then you have made money in the amount that you received for the call.
When you sell a put, you're obligated to buy the security at a specific price. What if the market goes down? Then the buyer of the put can exercise his option and sell the security to you at a higher price. You now own a security that is worth less than what you paid for it. Again, if the market goes up, then the put you sold will probably expire worthless and you will have made money.
To summarize, buying puts and calls have limited risk while selling calls and puts can have unlimited risk. There are exceptions when you employ different strategies, such a covered call writing, but that is beyond the scope of your question. If you are interested in trading options, I would advise you to work with an advisor who has both the knowledge and experience in this area.
Under the scenario you described in your question, yes that is correct. My suggestion would be not to trade options until you have a better understanding of the pros and cons and also how each type of option works. There are lots of different classes out there that are really good.
If you are a buyer of Options, meaning you buy a Call or buy a Put, you can never lose more than your premium paid. This is because you bought the right, but not the obligation to exercise. Only the buyer can exercise the option on the seller, or writer, of the option. So the seller/writer takes in a premium and an obligation to deliver shares or buy shares at a predetermined, specified price, known as the strike price.
If you sell a call, then theoretically your loss could be infinity (but never is) because the stock could take off to the moon. If you sell a put, the stock can only go to zero. Therefore, if you sell a put, your max loss is the Strike Price minus the premium received. So if a stock is $100, and you sold a put for $5, your max loss if $95/share.
Best of luck, Dan Stewart CFA®