Options are extraordinary trading instruments that open up a world of possibilities for traders (not for nothing they are called “options”). The name of our company stands behind that pillar of offering possibilities by offering Lots of Options.
The ability to manipulate trades when trading options translates into endless possibilities for the generation of income or capital gains.
While one should not over-leverage when trading options, such as in the case of Long Term Capital Management in the 1990s, when used responsibly, options can create vast wealth, limit downside, and define upside so that you can examine risk first and evaluate gains second.
To better explain the benefits of trading options versus other instruments, let’s imagine two scenarios:
- One morning the market shifts because of the CoronaVirus, the Asian Contagion, or Irrational Exuberance as Former Fed Chairman Alan Greenspan called it, or because the mortgage bubble bursts. If you own 20,000 shares of the S&P 500 Spiders, your loss would be 20,000 times the number of points that the market falls and possibly continues to fall as you hope and pray that one day you make your money back.
- You control 20,000 shares of the S&P 500 Spiders and you have a five dollar credit spread. As opposed to the possibly life changing losses you would have in the case above – especially if you are trading on margin, – a five point credit spread means limited risk to the 5 points minus what you received from the credit of the trade, and in a time of crisis, five points are not only normal, but manageable.
In the example above, the credit spread would have offered more protection and even allowed for the changing of position by moving to a debit-spread in the direction of the short side, with less damage to the overall portfolio. Something that owning naked shares of stock would not have allowed.
Without a crystal ball, traders rely on charts, market profile indications, and market internals, and try to be as objective as possible, but bias and emotions often come into play for both seasoned and new traders. Knowing that risk is sometimes inevitable, trading options are a great way to limit that risk.