Option Risk - Are Options Riskier Than Stocks?
Apr 7, 2016
There are more steps and paperwork to trading options as opposed to trading stocks. Brokerage firms tell you this is because there are more risks trading options. But are there really?
Opening a stock trading/investing account is about as cumbersome as buying an over-the-counter medication. Maybe you need to show I.D., but that’s about the extent of the process. You are trusted to know what you are doing. Want to open an options trading account and it’s more like buying prescription medication.
After opening the stock trading account, you’ll need to fill out forms for options trading. But options accounts come in different varieties. Basic buying of options and selling covered calls is one option. Selling spreads? That’s another option. Want to sell naked options? That’s a third option. And if you want to maximize your money using margin, there’s another step.
Most brokerage firms tell you all these steps are to determine “suitability”. You may be smart enough to save money and understand the benefits of putting that money to work, but someone else entirely will decide what is suitable for you. Apparently, you aren’t that smart.
The added steps required to trade options perpetuate the myth that trading options is riskier than stocks. Is it possible to lose money trading options? Sure. It’s also possible to die from a shark attack on the beach during vacation. Statistically speaking, odds of a shark attack are low. Trading options has risks but those risks are no worse than trading stocks.
Options trading offers some distinct advantages to trading equities. To begin, we can control our entry. We know entering a trade 45 days prior to expiration is the point when theta decay accelerates, an advantage not available in equity trading. We can also choose the appropriate strategy depending on the level of implied volatility.
In an options trade, we can calculate the probability of being profitable. We can also calculate the probability of making 50% of the total premium sold. The only probability in equity trading is a 50/50 chance.
Another distinct advantage unique to options trading is not having to pick direction. Because we can calculate a stock’s expected range in a given period of time, we can sell options with strike prices outside of that range and remain directionally neutral. This gives us the added benefit of not needing to pick the right direction at the right time.
So why the extra hurdles opening an options trading account versus just a regular stock trading account? In a word, control. Complicating the account opening process with additional paperwork gives the illusion options trading is inherently more risky. Additionally, making the process more cumbersome leads many to just give up out of attrition. Both scenarios lead retail investors back to the products controlled by brokerage firms.
None of this is meant to suggest options do not have risk. They do. At tastytrade, we provide our audience with the tools and education needed to understand probabilistic outcomes as well as the mechanics for executing smarter trades. We can’t eliminate risk altogether...in life or in trading. We just believe in taking smart risk by trading probabilistic outcomes that are not directionally dependent.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see:
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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