Options Trading Advice: Use Caution, but Fear Not

Caution is good; Fear is not

Stock Options
••• Stock Options. Micheal O Fiachra / EyeEm Getty Images

Stock options have been trading on exchanges since April, 1973. Yet, to this day, some investors and traders are afraid to learn anything about options and how they work.

There are two basic reasons why that is true:

  1. People are afraid of something that they do not understand. In the financial world, that is a reasonable way of thinking. There are plenty of scammers whose job it is to separate traders from their money. Thus, avoiding scams requires paying attention. The sad truth is that too many investors take advice and suggestions from untrustworthy folks -- and pay the price for being careless.
  1. Novice investors believe that options are difficult to understand and that it is wise to avoid problems, simply by ignoring anything related to options trading. The truth is that options are easy to understand -- it is putting that understanding to use that is more difficult. Learning something new is a good thing. However, there is no requirement that the education be put to use. That decision should be based on how well you mastered the general concepts.

Learning About Options

The good news: If you ever bought an insurance policy, used a transfer on public transportation, or requested a rain check from a retail store -- then you already understand the most basic concepts about options: You own the right to buy or sell something -- but there is no requirement that you make the purchase/sale. 

The bad news: Although it is easy to understand how options work, it takes more education before you are capable of understanding option strategies.

No one can read a few pages and expect to translate that information into cash. For example, you may understand why bullish people buy call options: They may earn a high return on their investment. However, it takes an options education to understand which options to buy and which to avoid. It takes study before you can intelligently choose a specific option strategy.

Plus, with options, timing is everything (because options have a limited lifetime).

One financial newspaper columnist whom I respect feels that it is best for her readers to avoid options. The primary rationale for that is pretty basic: When unsophisticated investors hear about something that can increase profits, all too often they jump right in -- and end up losing money. Thus, in order to "do no harm" the journalist does not want to see any of her readers using options without sufficient education. I get it.

She knows that she can issue warnings, but that greedy and/or foolish investors will ignore those warnings.

That's not the situation here. You clicked on a link to learn something about options. I trust that you will exercise due diligence and spend some time reading about option basics and simple strategies. I hope that you believe in my frequently stated opinion: "Managing risk is the single, most important principle for the successful trader." 

So Why Should You Learn About Options?

  1. Options can be used to reduce risk while trading. Translation: You can trade with less money on the line; you can increase the probability of earning money on any given trade -- if you are willing to accept limited profits.
  1. Options can be used to hedge (reduce the risk) of owning stock-market investments. It is possible to establish a maximum sum that can be lost -- just as one does with an insurance policy.
  2. For more experienced traders, options allow you to place a bet on (whether the market will be more, or less,volatile in the future).