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?

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March 2017

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®

March 2017
March 2017