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Nobody is arguing about the long side of options being "oh god run for the hills nuclear weapons dangerous", they are arguing that about the short side (or cert
by gfodor 14y ago
Nobody is arguing about the long side of options being "oh god run for the hills nuclear weapons dangerous", they are arguing that about the short side (or certain complicated strategies that are long-short.) The long side is just a suckers bet, but it's a relatively low risk one. You buy a $1000 call -- most of the time you lose the $1000. Sometimes you break even. Rarely you make a little money. Once in a blue moon you 2 or 3x your money. (These are the instances you remember and hence you keep buying calls.) In the long run, you lose money (academic studies have shown this.)
Where you can really get screwed is going (naked) short. Lets say you shorted a "modest" $1000 worth of out-of-the-money GOOG options today with a 8% spread from strike. The $600 Dec 22nd puts right now cost $2.80, so you'd sell 4 contracts for $1120. 8% is plenty of cushion, right? As long as GOOG's price doesn't go down more than 8% before expiration, you'd have $1120 in your pocket. That's a huge drop and highly unlikely. An easy $1120, right? It worked last month and the month before, so why not this time?
But oops, lets say just like last time GOOG's earnings leak early because someone fat fingered an email or something, and the stock took an instant 12% haircut. That extra 4% below your strike price just cost you approximately $24 per share. You had 4 contracts, so your options were against 400 shares. You just lost $24 * 400 shares = $9600 in order to make an "easy" $1,120.
Now, consider the fact that many people are going to be looking to make more than $1,000 a month when trading options. More like $5,000-$10,000. Guess what -- if the market systematically crashes by 10% over a few days because Ben Bernanke sneezed during a speech you could be in the hole for hundreds of thousands of dollars depending on what positions you've taken.
Also, if you were to buy closer to-the-expiration options (say, ones expiring next week as opposed to next month), the per-contract costs go down by approx a factor of 10, so you have to sell 10x more contracts in order to get the same gain. But guess what, if your luck is particularly bad and something goes horribly wrong, you can multiply your losses above by a factor of 10. (Yes, Virginia, with options it is possible, nay, easy to have a 10,000% loss in a few minutes on a bad day.)
That's how you can get fucked. You keep selling short puts on positions you can't really cover comfortably, and rake in the dough. And then on one sunny otherwise uneventful autumn afternoon something weird happens, and Vegas, er, I mean, Wall Street, takes it all back, and much more.
- confluence 14y agoGreat comment gfodor. I like to think of it like this. Buying options is like gambling at a casino. Statistically you will just keep losing money because the house always wins - they have the edge - unless you play a game like poker with a bunch of suckers - where the casino still takes a nice chunk of your change. Selling options is like being a casino without the ability to know what the statistics of the underlying distributions or their payoffs are. Nor do you have the ability to kick a guy out if he wins too big and too often. It's a casino without the control. And a casino without control - is a casino that goes bankrupt.
- dkhenry 14y agoSo your saying if you don't manage your risk you will lost a lot of money ? Thats goes without saying which is why its called risk. The purchase I talked about exposed me to my purchase price in risk. In reality the risk was less since _everyone_ for every stock purchase should always set trailing stops to limit risk. In my theoretical trade of purchasing a put option on GOOG you are exposed to a maximum of you outlay in risk ( no ballooning risk ) and if like you should you set a trailing stop you further limit your risk to a small subset of the initial outlay. Also to further prove that your wrong. The SEC has rules in place requiring that investors are not allowed to have to mush risk in their portfolio. Had you done what you jsut claimed and did a naked short on GOOG with no protection you would have been required to either pony up a large cash reserve ( protecting your broker from the liability ). Most responsible brokerages won't even allow your trade to go through unless again you have a large enough portfolio to absorb any reasonable risk. This by the way is only using options for speculation. They have lots of other useful purposes and you haven't even discussed things like covered calls and using options as insurgence against volatility.
- gfodor 14y agoIt doesn't seem that your read my comment since my entire point is that you seem to be acting like the buy-side of options is the 'nuclear weapons' the OP is warning people about. The buy side of options is perfectly "safe" since it is only really leveraged on the upside. It's the sell side that is a concern and requires extreme caution since it is leveraged on the downside. I'm not sure what you are claiming I am "wrong" about since nothing I said in my previous post was an opinion but simply explaining facts around the risk factors involved to make sure readers of this thread don't mix up the buy side and sell side of options and their associated risks. You can get naked put option permission at many brokerages once you have done some trading. Also your point about stops is irrelevant: the way you get burned by short options isn't from a stock price slowly grazing down past your stop, it's when the value of the company objectively changes by 5-10% overnight or instantly intra-day due to some event or disclosure. The rarity of this situation is the very reason that the risk in short options is easy to ignore since you are selling insurance against tail risks and usually don't have to pay up to the buyer. (Covered calls can be viewed as 'income for the price of potential gains' or 'insurance for short sellers' depending on how you want to view it. The same argument applies on both types of options.)