Thursday, April 12, 2007
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Stock Trading vs Options Trading
Option trading is much more complex and risky as compared to stock trading.
When investing in stocks, you only have to worry about one thing, which is price; whereas in options trading, there are additional variables that influence an option's price.
In order to be profitable in stock, you need to be right in the expected direction of underlying stock price movement. In options, on top of that, you also have to be right in the expected magnitude of the movement as well as the time needed for the movement to happen. As a buyer of an option, you will want the expected movement to occur quite soon so that the time value lost will be minimal, and the magnitude of movement is big enough to cover the loss in time value while waiting the stock to move. If either of these two is wrong, you might still lose money although the direction is correct.
Additionally, due to the leverage effect, if you are wrong, if you could have higher % loss from options trading than from stock trading, given the same move in the underlying stock price. Although in terms actual dollar, the loss from options trading should be smaller than it does from stock trading, provided the number of shares are the same.
When investing in stocks, you only have to worry about one thing, which is price; whereas in options trading, there are additional variables that influence an option's price.
In order to be profitable in stock, you need to be right in the expected direction of underlying stock price movement. In options, on top of that, you also have to be right in the expected magnitude of the movement as well as the time needed for the movement to happen. As a buyer of an option, you will want the expected movement to occur quite soon so that the time value lost will be minimal, and the magnitude of movement is big enough to cover the loss in time value while waiting the stock to move. If either of these two is wrong, you might still lose money although the direction is correct.
Additionally, due to the leverage effect, if you are wrong, if you could have higher % loss from options trading than from stock trading, given the same move in the underlying stock price. Although in terms actual dollar, the loss from options trading should be smaller than it does from stock trading, provided the number of shares are the same.
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