Advantages and Disadvantages of Stock Options Trading.

[ntrader 10]

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

[ntrader 10]

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

What i don't like about options is that are a decaying asset, the time value of the price gradually diminishes as the option approaches expiration, at which time it becomes zero.

[Larry1234 10]

I would rather say option comes with a high risk and return profile. In simple words, the person who shorts the options takes the maximum risk and his profit is limited compared to the Long party in option with a risk-return profile of limited loss and unlimited gain.

 

Apart from this, the worst part in option is it's a zero sum money. It means that it's not creating any wealth in the market. It's simply a loss to one party compared to profit to the other one.

 

 

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

[ntrader 10]

One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

[SIUYA 11]

One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

 

Here in lies the great/confusing part of options. what is one persons advantage may be the others disadvantage.

 

Add

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

various strategies can be used across months and strikes.

can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

zero sum - if you are constantly loosing and have no way of offsetting this

various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

Limited Downside - if short options

 

Bascially - there is a lot options can offer, and there are a lot of advantages and disadvatanges and these differ greatly on if the options used are long, short, puts, calls, naked or covered.......you cannot be general with them.

[ntrader 10]

Thank you for your reply SIUYA, you are right, most of the times the advantages of options for some traders are disadvantages for some other traders and you are right that you can't be general with options. Your post was very helpful. So here is how our list looks like now:

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

Various strategies can be used across months and strikes.

Can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

Zero sum - if you are constantly loosing and have no way of offsetting this

Various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

[informer1 10]

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

Trading in binary options has increased substantially in recent years. In an earlier era, binary options trading had to be done through a specialized broker who charged high fees for the service. Today, people can visit a binary trade website and process the transaction themselves, making it both simpler and cheaper to trade binary options for fun and profit.

[guyentlab000 10]

when you zero sum - if you are constantly winning.

Did you mean your net is zero or someone else is losing as a result of your win? Thanks,

[Larry1234 10]

Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

[guyentlab000 10]

Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

[Larry1234 10]

Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

 

Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

[SIUYA 11]

Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

stocks are generally not thought of as a zero sum game. The main reasons being that stocks have a limited number of shares issued at any one time, they usually represent a claim over some assets or cash flow (eg; supermarket, banks profits). They can actually generate wealth.

Futures and options on the other hand merely require a buyer for every seller and these are viewed as a zero sum game......much like insurance.

 

see Zero-Sum Game Definition | Investopedia

see wikipedia for more info....

eg"Many economic situations are not zero-sum, since valuable goods and services can be created, destroyed, or badly allocated in a number of ways, and any of these will create a net gain or loss of utility to numerous stakeholders. Specifically, all trade is by definition positive sum, because when two parties agree to an exchange each party must consider the goods it is receiving to be more valuable than the goods it is delivering. In fact, all economic exchanges must benefit both parties to the point that each party can overcome its transaction costs, (or the transaction would simply not take place).

"

[Colonel B 10]

Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

This is fundamentally FALSE. The stock market is a market. The reason why prices go up on any stock is because buyers are willing to pay higher prices. Simple as that. Someone has to sell the stock to a buyer. So if a stock price has gone up for the last 25 years it is only because buyers chose to buy higher each year. Why would buyers collectively do this? For many reasons. It could be because they think that the company is undervalued. Or they perceive that the company will create or develop a new idea or technology. Companies simply do not reward you for staying with a company for many years through the payout of an increase in what you paid for the stock. No they reward you with dividends. Other buyers reward you not companies. A company is only worth what someone will pay for it.

 

The price of a stock is not directly tied to the value of the company either. It could be but only if buyers collectively use that. I would like to point out that at the peak of the last financial crisis there were many banks that suffered a loss on their stock price. The reason for it was the fact that they were banks and a majority of banks had problems. The entire financial sector suffered regardless if the company was or ever was involved with any sort of mortgage loans. This is similar to the housing market. If you have the nicest house on the street and a few houses on your block or in your area are run down then it diminishes the value of your house.

 

Here is an example of your fallacy. If you would of bought 10 contracts of ES a few years ago when it was at 700 and then sold it today at 1517 you would be up. So based on your example the ES generated wealth. And this is based on a supposed index of more then 1 company. Given the example so far the ES seems to be a better form of generating wealth. Also you can short sell stock. This in effect is similar to a futures trade in that you are not required to "own" something before selling it.

Edited February 14, 2013 by Colonel B

[guyentlab000 10]

Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

[Larry1234 10]

'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

 

I guess you have interpreted wrong my friend. I made the comparison between stocks and Derivative market.

 

Before answering the question, "Do stock market really create wealth" ?

 

Let us first understand the nature of stock markets. A stock market is a place where people can buy and sell their shares in companies. The price at which they buy and sell is determined by demand and supply of shares at that point in time. In other words when marginal demand for shares is plentiful relative to marginal supply, prices will rise and vice versa. The key to stock market prices is marginal demand and supply. People who buy and hold shares for the long term ensure that marginal supply does not increase thereby keeping a floor under prices until they decide to sell. As long as buy-and-holders keep buying, we can safely assume a rising floor for prices. Once they decide to sell, the floor collapses.

 

Company profits have a role in influencing stock market prices i.e. in attracting people to buy the company’s shares. A company with a long track record of rising profits attracts a large number of buy-and-holders thereby reducing the stock’s marginal supply while simultaneously increasing marginal demand which effectively raises the price floor. Profits may be real or created by accounting manipulations. Both have the same effect on stock market prices.

 

Unfortunately, people forget that a track record of rising profits (either real or illusory) is unsustainable and has to break at some point in time. Profit disappointments cause the price floor to break. Once broken, it is near impossible to stop from going down significantly at a pace determined by the buy-and-holders. Real profits erode slowly while accounting illusions disappear rapidly. Hence the decline of really profitable companies is slow whilst it is rapid for those companies whose profits are illusory.

 

Wealth is measured as an increase in nominal net worth. As long as stock prices rise, your wealth increases while it decreases when stock prices fall. It is clear that you have exit at the right time for your wealth to sustainable increase. Exiting at the right time requires a lot of ability and luck.

 

There are investors who have held stocks for decades and have generated tremendous wealth just by holding on to those stocks. The key reason for this growth in stock market wealth is the massive increase in money supply. As long as money in the system remains constant, price rise in one stock is usually accompanied by fall in another as money to buy can be generated only by selling. This would ensure that the market cap of the stock market remains constant. But if money in the system increases, buying can be done without selling thereby raising the overall market cap. Unfortunately, we have lived in an inflationary world for so long that people have come to accept it as a natural reality rather than a political choice. This has lead to the belief that stock markets always rise in the long run and equities generate tremendous wealth.

 

But on the other hand, Derivatives never generate wealth. I hope this is clear.

[ntrader 10]

A zero sum game is one where for every winner you must also have a loser. In trading it means that for every person who turns a profit someone else must suffer a corresponding loss.

[ThetaTrend 10]

I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

[ntrader 10]

I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

 

Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

• Leverage - requires good risk controls
  
• Hedging
  
• Decaying asset - when you are short
  
• Zero sum - if you are constantly winning.
  
• Various strategies can be used across months and strikes.
  
• Can be used as part of a portfolio hedging strategy
  
• Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  
• Limited Downside - if long options
  
• Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  
• Dividend and corporate strategy plays - dependent on local laws
  

 

Disadvantages:

• Excessive leverage when risk controls are poor
  
• Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge
  
• Decaying asset - when you are long
  
• Zero sum - if you are constantly loosing and have no way of offsetting this
  
• Various strategies can be used across months and strikes -dangerous if you dont understand what you are doing
  
• You might not have enough capital/assets to effectively implement a portfolio type strategy
  
• Unlimited downside - if short options, (subject to expiry, and if put or call) - See more at: http://www.traderslaboratory.com/forums/options-trading-laboratory/15289-advantages-disadvantages-stock-options-trading.html#sthash.2SI5duhZ.dpuf
  

[Larry1234 10]

Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

• Leverage - requires good risk controls
  
• Hedging
  
• Decaying asset - when you are short
  
• Zero sum - if you are constantly winning.
  
• Various strategies can be used across months and strikes.
  
• Can be used as part of a portfolio hedging strategy
  
• Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  
• Limited Downside - if long options
  
• Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  
• Dividend and corporate strategy plays - dependent on local laws
  

 

Disadvantages:

• Excessive leverage when risk controls are poor
  
• Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge
  
• Decaying asset - when you are long
  
• Zero sum - if you are constantly loosing and have no way of offsetting this
  
• Various strategies can be used across months and strikes -dangerous if you dont understand what you are doing
  
• You might not have enough capital/assets to effectively implement a portfolio type strategy
  
• Unlimited downside - if short options, (subject to expiry, and if put or call) - See more at: http://www.traderslaboratory.com/forums/options-trading-laboratory/15289-advantages-disadvantages-stock-options-trading.html#sthash.2SI5duhZ.dpuf
  

 

Adding to your point, Options are really useful for hedging. If the trader has the knowledge of option Greeks (mainly delta and gamma) then they can use the same and easily manage their risk and return profile.

[ntrader 10]

Options basically created for hedging and soon speculators jumbed in to make some extra profits in the new market. Greeks are useful tools in the hedging procedure.

[Larry1234 10]

Options basically created for hedging and soon speculators jumbed in to make some extra profits in the new market. Greeks are useful tools in the hedging procedure.

 

We all know that options were earlier introduced for Hedging but due to its payoff profile, it attracts traders to come. Options is equally traded by arbitrageurs as well.

[ntrader 10]

I believe that today most of the participants in the options markets are speculators, hedgers are the institutionals investors and hedge funds.

[Larry1234 10]

I believe that today most of the participants in the options markets are speculators, hedgers are the institutionals investors and hedge funds.

 

Don't forget Arbitrageurs, they are also one of the big market participants. They play in big volumes, but frequency is less.

[ntrader 10]

Wth options you can take a position with very low capital requirements. A trader can do a lot in the options market with $1,000 but not so much with $1,000 in the stock market.

[ntrader 10]

Forecasting option pricing, even given the price of the underlying currency, is very difficult.