Investments: Option trading 101

OGputtnfool

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What do I need to know about option trading? My kid has a friend who's apparently into it and he wants to try it. Everything I know says it's very high risk. Where can I educate myself?
 

MWard

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Gotta say, it's super super risky if you have no idea what you're doing. You can legit lose your butt really fast if you're not careful.
 

OGputtnfool

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Gotta say, it's super super risky if you have no idea what you're doing. You can legit lose your butt really fast if you're not careful.
Thanks. I'll watch that. So, is it safe to say I can lose more than is in my account? I mean, if I put $50, $500, or $5000 into an account, I can obviously afford to lose it, but if I put $5000 in, I don't wanna find out I'm out $50k.
 

MWard

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Thanks. I'll watch that. So, is it safe to say I can lose more than is in my account? I mean, if I put $50, $500, or $5000 into an account, I can obviously afford to lose it, but if I put $5000 in, I don't wanna find out I'm out $50k.
Someone who is way smarter than I am can answer that, but yeah you can get burnt pretty bad if you're not careful. It is basically a contract, after all.
 

tahoebum

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Thanks. I'll watch that. So, is it safe to say I can lose more than is in my account? I mean, if I put $50, $500, or $5000 into an account, I can obviously afford to lose it, but if I put $5000 in, I don't wanna find out I'm out $50k.
An option buyer has limited risk but an option seller has much greater downside risk. You need to be approved to trade options, btw.

 

wubears71

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It’s a great tool when you have insider knowledge. ????

In All seriousness its so tempting. My wife works for a $2.4B publically traded company and is the VP of finance (reports to the CFO) and I could make $$$$$$$$$ on options if I traded on insider info. But I know better not to do so.

Options are honestly legalized gambling.
 

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Don't do it unless you are Hillary Clinton
 

tahoebum

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It’s a great tool when you have insider knowledge. ????

In All seriousness its so tempting. My wife works for a $2.4B publically traded company and is the VP of finance (reports to the CFO) and I could make $$$$$$$$$ on options if I traded on insider info. But I know better not to do so.

Options are honestly legalized gambling.
Legalized gambling indeed, lol. I could have done the same when my wife had insider knowledge working for a large tech company for 18 years in CA but I don’t think I’d do well in prison. :LOL:
 

wubears71

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Legalized gambling indeed, lol. I could have done the same when my wife had insider knowledge working for a large tech company for 18 years in CA but I don’t think I’d do well in prison. :LOL:
Prison is a major motivator for not breaking the law.
 

Gman79

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Careful with options - money comes out way to quickly because its all hope that your price is a deal for someone to buy. if the floor collapses... well the fall might hurt. From my point of view you have to spread the money out so that one big gainer can absorb the losses.... almost a group trade that could yield a big win or multiply the hurt in a big loss.
 

tahoebum

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It’s a great tool when you have insider knowledge. ????

In All seriousness its so tempting. My wife works for a $2.4B publically traded company and is the VP of finance (reports to the CFO) and I could make $$$$$$$$$ on options if I traded on insider info. But I know better not to do so.

Options are honestly legalized gambling.
Prison is a major motivator for not breaking the law.
Yep, as many here may not know, they sent Martha Stewart to prison for 5 months for lying about a stock sale.
 

dhartmann34

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Thanks. I'll watch that. So, is it safe to say I can lose more than is in my account? I mean, if I put $50, $500, or $5000 into an account, I can obviously afford to lose it, but if I put $5000 in, I don't wanna find out I'm out $50k.
Depending on what you do, there is definitely the possibility of unlimited losses...

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OGputtnfool

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So, does it change anything if we don't write the options and just buy (?) them?
 

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It's been a few years since I studied about options but I do believe you could do some covered calls or straddles to limit your risk.
 

OGputtnfool

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Gotta say, it's super super risky if you have no idea what you're doing. You can legit lose your butt really fast if you're not careful.
So, let me see if I get this right. It's entirely possible that I watched that entire 1 hour video and still don't understand it.

If I buy a call option for $3 with a strike price of $125. That means I paying $300 up front for the option to buy $12,500 worth of shares before expiration. If the share price reaches $150, then I want to buy it because I'll effectively make $25/share or $2500, right?

Assuming that's all accurate, what if I don't have $12500 in my account? Can I buy them and immediately sell them for $150/share so I simply get $2500?

So, my max loss in that scenario would be $300 with unlimited potential gains, right?
 

MWard

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So, let me see if I get this right. It's entirely possible that I watched that entire 1 hour video and still don't understand it.

If I buy a call option for $3 with a strike price of $125. That means I paying $300 up front for the option to buy $12,500 worth of shares before expiration. If the share price reaches $150, then I want to buy it because I'll effectively make $25/share or $2500, right?

Assuming that's all accurate, what if I don't have $12500 in my account? Can I buy them and immediately sell them for $150/share so I simply get $2500?

So, my max loss in that scenario would be $300 with unlimited potential gains, right?

Like I said, above my pay scale on knowledge. If my lmited knowledge is correct however, see the following example below

You find a stock at $100 a share. You have 1k. You can either buy 10 shares at 100, or 100 shares at the option price at 10. Aka, you're buying 10x the amount. Now your strike price is at 125. If that hits, you sell and you make profit. If it doesn't hit, say it gets to only 120, and here's where I get fuzzy.. I think you have to buy those shares at the market rate of $120 per share. So yeah, your 1k gamble became a 11k loss.
 

Gman79

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Like I said, above my pay scale on knowledge. If my lmited knowledge is correct however, see the following example below

You find a stock at $100 a share. You have 1k. You can either buy 10 shares at 100, or 100 shares at the option price at 10. Aka, you're buying 10x the amount. Now your strike price is at 125. If that hits, you sell and you make profit. If it doesn't hit, say it gets to only 120, and here's where I get fuzzy.. I think you have to buy those shares at the market rate of $120 per share. So yeah, your 1k gamble became a 11k loss.
not sure I agree with your logic, but also not an expert....

When buying or selling options, you have the right to exercise that option at any point up until the expiration date. Meaning if the stock goes higher you would execute the option buy the shares and sell the stock.... OOOOOOR you can sell the option to someone else as the option would also gain value because someone else can buy the option and excercies... just a matter of capital to invest. Long story short ... buying or selling an option doesn't mean you actually have to exercise it at the buy/sell point
 

MWard

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not sure I agree with your logic, but also not an expert....

When buying or selling options, you have the right to exercise that option at any point up until the expiration date. Meaning if the stock goes higher you would execute the option buy the shares and sell the stock.... OOOOOOR you can sell the option to someone else as the option would also gain value because someone else can buy the option and excercies... just a matter of capital to invest. Long story short ... buying or selling an option doesn't mean you actually have to exercise it at the buy/sell point
Ahh see I didn't realize you had that option to cash out whenever you were like nope don't like don't like. I thought it was basically a contract you were stuck with. So that part's good to know.
 

OGputtnfool

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Ahh see I didn't realize you had that option to cash out whenever you were like nope don't like don't like. I thought it was basically a contract you were stuck with. So that part's good to know.
It's my understanding that if it doesn't get to the strike price, it expires with no requirement to buy. So, I'd be out the cost of the option only. If it gets to the strike price on/before the expiration date, I can exercise the option to buy it.

At least that's my understanding.
 

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tahoebum

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Trading options ramps up the the complexity of a "normal" investment by a huge order of magnitude and has substantial risks which are not alway obvious. The people selling option trading services gloss over these aspects and if you are good enough to make money trading options on your own you'd likely be working for Goldman Sachs or another big investment bank. Our financial advisor is ranked by Barron's as one of the top 250 in the country and she advises against options. When I was younger I thought I was smart enough to trade a few options and I lost money, fast.

If this formula makes sense to you, go for it, lol. :)

Screen Shot 2020-02-06 at 11.44.09 AM.png
 

OGputtnfool

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Trading options ramps up the the complexity of a "normal" investment by a huge order of magnitude and has substantial risks which are not alway obvious. The people selling option trading services gloss over these aspects and if you are good enough to make money trading options on your own you'd likely be working for Goldman Sachs or another big investment bank. Our financial advisor is ranked by Barron's as one of the top 250 in the country and she advises against options. When I was younger I thought I was smart enough to trade a few options and I lost money, fast.

If this formula makes sense to you, go for it, lol. :)

View attachment 8926863
Thank you for the constructive reply. Do you, by chance, know what you lost big on?
 

tahoebum

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Thank you for the constructive reply. Do you, by chance, know what you lost big on?

The details are not important but I had won on some smaller trades over a few months and decided to make a bigger bet that Broadcom would go up over a few week period and I was wrong - it wiped out all my earlier gains.

It was a good lesson and led me to diving into a few dozen books on different investing strategies and find one that was a much better fit for our investing style. It has not been all smooth sailing as my wife and had to fire a couple financial advisors but found a great one a few years ago. I'm now a "boglehead" and also a huge fan of Warren Buffet.

Btw, The market is up over 500% since the low point after the financial crisis at the end of 2008.

A couple of my favorite Buffet quotes:

  • We don’t have to be smarter than the rest; we have to be more disciplined than the rest.
  • I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.
  • Do not save what is left after spending, but spend what is left after saving.



Screen Shot 2020-02-06 at 12.09.46 PM.png
 
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OGputtnfool

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I wasn't worried about which stocks, etc. More curious about if you were buying call option, selling put options, etc.
 

tahoebum

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I wasn't worried about which stocks, etc. More curious about if you were buying call option, selling put options, etc.
Buying a call option but it was a big bet at the time, about six months of my take home pay. It hurt to have it expire worthless. ?

You could have had easily a 30x return on your investment by trading Telsa call options the last 6 weeks if your hunch told you the stock was going up and have the stomach for it. I told a buddy on Tuesday night that if I had any balls I'd short Tesla stock. It went down from $961 to $726 yesterday but I'm too chicken to jump into trading options ever again.:)
 

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