Why doesn't everyone trade using options?
From what I've read about options trading, it seems as if you can really only lose the premium you put in. If that's the case, why doesn't everyone just buy options? Is there an underlying risk besides losing your premium that I'm not seeing?
Yes, you can only lose your premium when buying options, calls, or puts. But if your timing isn't right, you can lose the entire premium or 100%. And expectations are already priced into the options, so the stock must move more than the priced in premium for you to be successful. This is known as "implied volatility" and "expected move." You need to understand these terms thoroughly and know the "greeks," especially delta (% move in option for a % move in stock) and theta (time decay) to be successful in options. So, it isn't as easy as one might think, and if you do it incorrectly, you are just giving premiums to the writers of options, usually professionals. They will make you "pay up" for buying the option. And then options expire worthless and time is against you, whereas if you own the underlying security and it moves against you, you still own the security and time is on your side.
If you are new at this and are trying to learn, at least go out 3 weeks or a month to give yourself time, and only do a few contracts. If you go too short in time and then the stock moves against you, theta decay really kicks in and you will lose quickly.
Also, there are many "classes" teaching buying options around earnings and the associated increase in volatility. But most investors/traders wait until the week before or even the week of the stock's earnings announcement before buying the option. By then, prices have already gone up and premiums are too high. If you are contemplating an earnings strategy, which is difficult anyway due to surprises or lack thereof, you should consider buying the options approximately 3 weeks in advance so premiums haven't already risen yet in anticipation of the volatility around earnings.
Research Delta 70 Calls if you are buying calls. Most retail investors buy out-of-the-money (OTM) options because they are "cheap." This is a big mistake because small moves against you quickly losses all value. In-the-money (ITM) options hold their value much better when the stock moves against them, and it gives you time for the trade to either work out, make an adjustment like "rolling" the option out in time, or salvage some of your premium.
If you do not understand these terms above, please research and understand them first. Then, you can either "paper trade" for practice or at least do small size.
I am not trying to scare you, but rather shed some light on a few ideas and pitfalls. Options are a great tool and we use them in our shop in small increments for certain clients, but they are anything but simple.
Hope this helps and best of luck, Dan Stewart CFA®
A few thoughts:
Losing your premium can be a lot over time, so that isn't to be discounted. Premiums are based on risk, and so if you think that you need options, then you will pay more for them when you actually do!
Next, if you are suggesting that put options are appropriate for risk mitigation, then you are only looking at the possible short-term stop-loss, and you are missing the second decision that you actually have to make without an option of when to buy back in.
I'm still meeting people today in 2017 that sold in 2009 that haven't bought back. Meanwhile, a simple strategy of tying assets to time horizons would have led to: 1) no options cost, 2) a higher value in stock investments today than in 2009, and 3) no decision making on the part of the investor who likely would have bought in higher than when they sold.
Options can be a useful tool if they are utilized in an appropriate fashion. If you are simply buying options as a bet on the direction of a stock or index, for instance, then you are correct, you can only lose your premium. But you lost that premium. Do that enough times and you have lost your money. Options are very volatile so the premium you paid can drop very fast if things don't go your way. Essentially, options are a very speculative bet and they only have a certain lifespan. So if you buy that option and it does not get "into the money" before it expires (meaning finishes above the strike price on the option you bought), then you get zero. The option expired worthless. You can even lose money when the option does finish in the money, but by not enough to cover the original premium you paid. Then you could get "exercised" and be forced to buy the underlying security even if that wasn't the plan. A lot can go wrong.
Perhaps the most compelling reason to be wary of buying options is that it is a big boys game. The option you buy is in all likelihood sold to you by a very knowledgeable and deep pocketed pro (banks, hedge funds, mutual funds, etc), someone who simply knows far more than you and can stay in the game far longer than you. Is that really the guy you want to be trading against? I hope not.
Consider closely using options in place of actual investment. It could be pretty painful. There's an old adage about options; How do you make a million dollars trading options? Start with 3 million.