Options Trading Advice For BeginnersThe best options trading advice I can give to a beginner is this: don't do it. It's too risky. Let me explain:
What Is Options TradingI will attempt to explain option trading in the simplest terms possible but it it's a somewhat convoluted scheme. I'll do my best.Stock Options are contracts to buy and sell the underlying equity at a particular price. These contracts are called puts and calls. You don't have to buy the underlying stock, you can just trade the option if you prefer. This is the big draw for amateur traders. A stock's options are always cheaper than the stock itself so, theoretically, you can make a lot bigger gain while investing a lot less capital. Here's a quote from an options trading advice site: "Trading stock options is where you invest a relatively small amount of money to buy a "contract" that controls something more expensive. Your research tells you that your contract will rise in value before a certain date. When it does rise in value, you're going to sell the contract for a higher price than you paid for it...." (The emphasis is mine.) Sounds great doesn't it? One problem is that researching a stock is basic fundamental analysis. But the market doesn't always trade on the fundys the way most fundalmentalists think it should. And then there's the problem of your research skills. How good are you at this? Professional analysts get it wrong on a fairly regular basis. Problem number two is that no one and I mean no one can accurately and consistently predict whether the price of a particular stock will rise or fall within a certain time frame. Granted, options contracts can be purchased several months prior to their expiration and the longer the time frame (to a point) the easier price movement is to predict. But, when you get down into the nitty gritty of when and at what price to take the trade, it gets complicated. You would have to know how to trade the underlying stock in order to know when to buy put or call options on it. Stock Market EducationLet me point out something you may already know about the stock market. You can learn to trade anything you want to trade.But, like a college education, it will require a substantial investment of time and money. At least several months and several thousand dollars. If you've got the money to learn to trade stocks , why not just do that and begin to recoup the cost of your stock market education right away? Why spend more money and more time learning options trading as well? Oh, but options are cheaper. After you factor in the added educational costs, the extra time and risk I'm not sure they are. A common argument used by stock options trading advice web sites is that if a stock--I'll use Potash corp. as an example since I just put on a position in (POT) today--is trading for $90 per share. One hundred shares would cost you $9,000. Say the options cost $3 per contract. For $300 you could buy 100 contracts. If POT shares rise 10% to $99 per share the value of the options contract would then be $9. You could sell your contracts for $900. Minus the $300 you paid, that's a $600 gain. I admit, this is a huge gain on such a small investment. If you had purchased the stock at $90 and sold it at $99 you would have made 10% or $900. Amateur traders are easily sold on online options trading for this reason. $300 vs $9,000. It looks like a no-brainer to them. But hold on. It's true that in terms of percentages, the options trade gave a higher yield. The stock trade, however, gained more in dollars. The last time I went shopping, my grocer was not accepting percentages, he would only take dollars. Also, stock trades don't come with a built in expiration date. If POT goes into a consolidation pattern and trades flat for weeks, I can just hold it until it breaks out. If your options contract expires before you've made a closing transaction one of two things will happen. If it's in the money it will be exercised and you'll have to pay $9,000 to buy the underlying stock. Or, if it's out of the money you lose your $300. There are a lot more ifs, ands, and buts I could warn beginners about in the way of giving options trading advice. In the interest of clarity, I'm going to leave it at this: options trading is best left to the professionals.
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