Options has attracted many investors because the “LEVERAGE” factor. By buying Options, investor will have ‘LIMITED” Risks and “UNLIMITED” Return. This means that you can pay a certain amount of premium (depending on the volatility) to get Unlimited Return when the stock/underlying assets is moving based on your expectation….. Good, isn’t it?
Well, hold your conclusions for a while and be CAREFUL on Buying Options...... the followings are the points that you MUST consider:
1. Options is a wasted Asset.
Every assets are subject to be depreciated, based on the their categories. Indeed, there is asset that can not depreciated such as land. Every Options contract has tenor, and options value will be substantially reduced approaching the expiration date of the contract. This is what we call it “Time Decay” factor. I am really reluctant to buy Options that have high “Theta”, which is Time Decay is very fast. Many Options seminars teach students either to Buy Call or Put Options to cultivate gapping event of certain stocks before earning announcement. Some of them even suggest to make “STRADDLE” position, where you have to buy Call and Put options with the same strike price in anticipation you can hit the big bucks no matter the stock will gap up or down. Nevertheless, they never talk about suggested options tenor that must be bought. As I said, on one month options tenor, Theta is very high and Time Decay is against to all Options buyer. By buying Straddle without knowing momentum and volatility, it is a recipe of loosing the trade.
2. Even the STOCK is running to your direction, the OPTIONS value does not Move……
Many investors do not know why the options value do not move as their expectation despite the stock is moving onto their direction. Options is a derivative product and it is quite complex. The options value is calculated based on “Theoretical Options Value” (such as Black Scholes, Binominial model) and there are many factors affect the value… such as interest, tenor, strike price, dividend, etc. So, before buying options, you have to know “Delta” or the degree of change in option premium in relation to changes in the underlying stock. Many investors want to buy cheap options with the expectation of having Unlimited Return. Well, this is definitely wrong. By choosing OTM (Out of the Money) strike price, you will have higher breakeven (in case of buying call option), therefore, the stock must increase higher than your expectation.
The OTM Call Options usually have lower delta less than .50, and this means your option value will increase very slow compare to stock increase.
3. Even the Stock is running to your direction, your still loose the trade -> the “TIMING” is wrong…
Many Option buyers want to cultivate momentum when stock is gapped up or downward and they buy one-month options since it is cheaper to do that. This is what usually a seminar teach people to see which stock candidate that will bouncing up or down after earning announcement. Well, it may be right that due to good earning result, stock is increasing and running to their direction. But most of the time, the timing is wrong, means the stock is running/rallying after the option is expired. The direction bet is right, but the timing is wrong, and this is happening again and again….
4. You buy Pricey Options….
Every trader must do buy low - sell high. This is also work for Options trading. Options buyers bet options value to increase substantially. But, some investors buy options not considering options price when they buy options, but only looking for momentum that they think can push the price higher. When earning announcement is still pending and nobody know the company’s result, “greed and fear” are influencing the market and usually this drive higher implied volatility and consequently the options price. Nevertheless, when the momentum is decreasing (or no great news anymore), usually volatility is down and also the options price. For option buyers who is using momentum to bet, they usually loosing the trade when volatility goes down.
