Options trading is dangerous. This article is directed at options trading beginners. Many new traders are unaware of the dangers involved in trading options. Options can be very confusing, and for that reason can make it very profitable for those who know how they work and very unprofitable for those who are confused. There is a reason why you have to.

Options trading is dangerous

Options Trading: This is how people go broke! So don't do this! // Options trading tips & strategies

Options trading is dangerous. The reason that options for trading purpose are considered risky is that they seem cheap but loose out value faster then other trading instruments. Mostly when options trading is done, it's about option buying that is discussed. How the max risk is premium you pay, which is very less as compared to size of position.

Options trading is dangerous


Historically, The Motley Fool has shied away from options as an investment vehicle, for reasons best stated by people smarter than we. Peter Lynch, a Foolish favorite around here, was not a fan of small individual investors using options. And we're ever mindful of Warren Buffett's first rule: Then again, as leveraging instruments, they can also amplify gains. Options have enjoyed a much higher profile in recent years, as trading volumes increased, curious investors dipped their toes into untested waters, and new specialized brokers entered the market.

Late-night infomercials feature alluring red-and-green-flashing software and testimonials from ordinary people who, with little to no training, claim to have made fortunes in the option markets. That last point is why we're here. This series is not intended for traders or sophisticated professionals employing complex arbitrage strategies or looking to trade volatility. Instead, we're hoping to give ordinary Fools a firm knowledge of what options are, and how we recommend using them in hopes of improving returns.

The best place to start would be to define exactly what options are. Options are derivatives -- they derive their value from an underlying "something else. For years, Warren Buffett has warned investors about the potential dire consequences of unchecked and growing derivatives use in capital markets. Then again, the Oracle of Omaha himself has used derivatives when he feels the market's offering him a value opportunity.

So we can understand why Fools might be confused by this seemingly contradictory behavior. But derivatives themselves of which options are only one part aren't inherently bad. The real problems stem from their wide proliferation, and the crazy accounting with which they're associated. Options are just tools, and they're only as good as the people using them. Shrewd use by well-educated investors can greatly enhance a portfolio's returns.

Reckless, ill-informed use of options, however, can badly damage your holdings. To use options well, you've got to have a healthy understanding of the intrinsic value of the business involved. Without that most Foolish of principles, how safe do you feel in using options to leverage returns?

You won't find descriptions here of option trading for trading's sake. If you're interested in day trading or "black box" software, look elsewhere. Most of those programs should come with warning labels, and some should be illegal. Don't look here for an option-only trading approach, either. We believe that options derive their value from real businesses, whose real worth can be estimated and employed as a sturdy foundation for a Foolish options strategy.

Many people, including plenty of folks in our Foolish community, have done very well by treating options as trading instruments. If you'd like to try to follow in their footsteps, we'll point you toward some resources that might help.

For the rest of you, sit back and relax. If you finish this series with a better understanding of the mechanics, risks, and potential rewards of options, we'll have done our job.

And, for those of us who are already familiar with the fundamentals of the options world, check out these more intermediate-level how-tos:. The Motley Fool has a disclosure policy. Skip to main content The Motley Fool Fool. Stock Advisor Flagship service. Rule Breakers High-growth stocks. Income Investor Dividend stocks. Hidden Gems Small-cap stocks.

Inside Value Undervalued stocks. View all Motley Fool Services. Learn How to Invest. How to Invest in Options.


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