An option is a contract that enables an investor to buy (known as a call option) or sell (referred to as a put option) an underlying asset at a fixed price over a specific period of time. Classified as a derivative, most investors use options to supplement income or to hedge against market downtown. In this article, Joel provides insightful and useful tips for options trading in 2020.
Many individual investors are enamored with options because of the high return potential. For me, options are just additional leverage. If you buy one share of a $100 stock you have to have a $100, but if you want to get access to the $100 stock and buy an option for it to go to $101 (for a $1/$100 or 1 percent gain if you owned the stock), you might only have to have 10c. If the stock goes to $102, you’ve made $1 on your option cost of 10c or a 1000 percent gain. So options can be all about leverage. Options also usually have a much higher commission cost than stock commissions, especially for institutional investors. Furthermore, the spread between the bid and ask can be quite large (as much as 50 cents at times). That means that when you are trying to buy an option, you might have to pay $0.50 more than you would at the same time to sell the option. And if, in fact, you made $0.50 on the option, in reality when you tried to sell it, you would not make any money (the $0.50 gain would be offset by the higher $0.50 cost to sell the option).
A great lesson on options and fear I learned in 2008:
We obviously could have just left the short position on without hedging the upside and made a lot more money, but we were fearful about the company being acquired. We had conviction in our top idea, but we didn’t have absolute faith