Why Stock Is More Risky Than Options!
You probably have been told that options are risky. Even worse, that you can lose your shirt trading them!
Well, what is the truth?
Let's take a look at stock ownership. What can happen if you buy stock?
The price can go up.
The price can go down.
The price can go sideways.
In the first case, you can make money. In the second you lose money.
And in the third case you don't directly win or lose but in fact it costs you money in two ways. The direct cost of brokerage and fees. And the indirect cost known as opportunity cost.
This is the cost due to lost opportunities. The fact that you aren't able to be involved in other, potentially profitable trades.
So if you purchase stock you can only make money if the stock price goes up.
Now some of you may be thinking, "But what about shorting?"
Well yes, short selling stock is possible but it is quite a tricky strategy and has almost unlimited risk so it is certainly not an approach we recommend.
You see, when you short a stock, you actually sell a stock that you don't own. And your intention is to then buy the stock back at a lower price. The price difference is your profit per share.
But can you see what the problem is here?
Well what happens if the stock price goes up? Particularly if it goes up a lot?
As you have sold the stock at a lower price you now have to buy it back at a higher price. And so your loss can be substantial.
So, to summarize, when you trade stock you can really only make money if the price increases.
Now there is one other aspect to this that I want to address. And this is that owning stock is expensive!
If you purchase 100 shares of a $50 stock it will cost you $5000. And if you buy it on margin it is still $2500.
That is a lot of money to outlay. And, more importantly it is a lot of money to put at risk. Especially seeing that you only have a one in three chance of the stock moving in the right direction.
Plus as stocks don't trend all that often you not only need to pick the right direction, you also need to be able to pick the right time.
So stock trading is not that easy. And it's expensive.
But options provide a great alternative.
For a start you only have to invest about 2% of what the stock was worth and yet you still control the same 100 shares.
So in the example above, instead of investing $5000, we might only have to outlay $100.
Plus, if you select the right strategy, you can profit no matter whether the stock price goes up; goes down or even goes sideways!
And finally, your risk is limited. The maximum you can lose is the amount you put into the trade. So in the example above - $100.
But the best thing of all is the leverage that options provide.
In the above example, if the stock price goes up by $5, the profit on the stock trade would be 10% or on margin, 20%.
But with this increase in stock price the value of the option might increase by 100%. And so the profit on the trade would be 100% - or ten times that of the straight stock trade.
So don't just accept the common view that owning stock is safe and trading options is dangerous.
If you understand options and learn how to trade them they can be a great investment vehicle.
David Chandler
http://www.StockMarketGenie.com
http://stockmarketgenie.blogspot.com/
Ordinary People Making Extraordinary Profits!
The above comments are offered for educational purposes only. We are not providing you with financial advice. We are simply sharing with you what has and hasn't worked for us personally. If you wish to trade or invest in the stock market you should obtain advice from a registered licensed advisor.
More Resources
Unable to open RSS Feed $XMLfilename with error HTTP ERROR: 404, exitingMore Stocks & Mutual Funds Information:
Related Articles
My Neighbor Got A New Car
I don't know what kind it is, but I saw it
on TV running full speed along the shore (I don't
live near the shore) throwing up spray or maybe
it was that one climbing up the steep mountain
trail thru the mud, rocks and snow. Very
exciting.
The Three Little Pigs Went to the Stock Market
Three little pigs went to the market to stock up for the future.The first little pig liked chips so he went to the DOW market.
Dont Fight The Fed
One of the great truisms of Wall Street is "Don't fight the Fed". For the long term investors this has resulted in greater profits.
Buy Low - Sell High
Now where have I heard that before? I know. It was my broker.
The Cub; II
We keep hearing about this bear market and that the bottom is "in" or "very close" so we should be invested in these bargain basement prices to take advantage of the next bull so we won't lose out on the expected huge profits.This is not a big bear market - yet.
Duck
Duck! No I don't mean a quack, quack. I meant get down, look out for a huge blob of brown stuff is heading your way.
Advisory News Letters
Several times each month I am solicited by various market touts who have a newsletter service, faxes or emails they are willing to send me to make me rich. That sure is nice of them.
Buying New Issues
Has your broker been calling you recently with the "great opportunity" to get in on a new Initial Public Offering? With friends like that you don't need any enemies.I don't care how good this new stock offering sounds.
Small-Cap Stocks: The Beginning of the Journey
When an individual investor wants to roll up his sleeves and do some research in the pursuit of the next big winner in the stock market, the place many start is in the small cap sector.As with the other capitulation sizes (capitalization is a stock's market value), no one can completely agree on a precise definition, but corporations under $2 billion are often considered small caps.
A Personal Stock Market Investment Philosophy
∙ Make every investment in the stock market a long-term investment.My Mother worked as a teller in a small bank in Dover, New Jersey.
Market Success
Who are the successful investors?There are those who follow the advice of their brokers and financial planners or those who choose to use their own good judgment? If you care to compare the results of the past 4 years from 2000 to now I believe you will see who as done the best job.In the old days at the Chicago stock yards they used to have an old sheep who led the lambs to the slaughter when they arrived on the train.
Duct Tape
Did you run out to buy that duct tape yet? Don't forget the plastic sheeting, bottles of water, canned food and a couple of books to read. What are you waiting for? I know - things to get better so you can resume your normal life style.
Bottoms Ups
If you have talked to a stock broker or financial planner in the last few days I will bet they all agree that there are some great bargains out there and now is the time to start buying in anticipation that the market will go back up. You will also find agreement from the talking heads on CNBC and those talk radio station stock mavens.
My Stock - Right or Wrong
We all know the expression, "My country, right or wrong", but have you ever thought about the stocks or mutual fund you own and said to yourself, "My stock - right or wrong" and held on to your position even as you saw your hard-earned money disappearing?This is the Buy N Hold strategy and, in case you haven't noticed, lost from 40% to 60% and more of investors' money from 2000 to 2003. Fortunately, for the past year stock markets around the world have gone up and folks have recovered about 25% to 30% from those low numbers.
What is the Most Important Indicator of All?
Most stock market traders have a favorite technical indicator.The one that they have the most confidence in.
Stock Market Diversification
In one of my previous articles (Investing in the stock market -9 powerful tips), tip number one was:1. Do not spread your money too thin.
Stuff
I continually hear from economists, talking heads, other market letter writers, analysts and assorted "experts" that I need to know all kinds of "stuff" about the stocks and mutual funds I am going to buy and I should keep up with them on a regular basis.What is this important "stuff"?Let's see.
Dollar Cost Averaging
Dollar cost averaging is one of the most popular ideas in the investment community. Everyone seems to like it and it has become a watchword among stock and mutual fund brokers.
Trade Stocks for Real
I read a comment by a forum member on another site earlier today that suggested that every investor should back test their system for at least twenty years. I disagree and will now tell you why.
Shorting Stocks - The Basics, Part I of II
What does it mean to short a stock?This means that you borrow the stock from your broker to sell to a third party. The idea is to buy back the stock at a lower price, returning the shares to your broker while leaving the remaining cash in your account as a profit.