Depending on your broker, you may have noticed how difficult it is to get approved for trading options. Why is this the case? Why are there more hurdles to jump through before you can start buying and selling options like a pro?
Simply put, options ARE riskier than stocks and bonds, but only if you don’t know what you’re doing.
Here are the main reasons why options are deemed only for investors with an iron stomach:
You Have a High Probability of Losing Your Entire Starting Capital When Trading Options
This is the first reason, and probably the most obvious. If you buy an option, regardless of whether it’s a call or a put, you have a very decent chance the option will ultimately expire out of the money and be entirely worthless. Primarily, this is because theta decay is working against you.
Of course, if you are on the other side of that trade, and you are short a call or a put, then you have a theoretically unlimited (although not really in practice) loss to the upside for a short call, and a massive loss to the downside for a short put.
In sum, large potential losses are the main reason options are deemed risky.
Options Use a lot of Leverage
Whether you are long or short options, you are inherently using leverage. Unless you are doing covered calls or puts, increased leverage can lead to outsized returns, and, unfortunately, losses.
This is one of the main reasons institutional investors don’t necessarily use options to express their market opinions. Typically, they have enough capital (billions and hundreds of millions) to take an outright position in underlying; they don’t really need the leverage of options. One exception to this is that institutional investors will use options for the different trading and investing strategies they provide which cannot be found elsewhere.
With all of this said, when options trades are sized properly, and risk is adequately monitored, options open up an entire new world of profit potential. ALL investments have some degree of risk, and options are no exception. For every fortune that has been made trading options, another has been lost. Nevertheless, options are unlike any other investment vehicle solely due to the strategies that they present, so don’t be intimidated by the “risk” of options.