One of the greatest and most talked about risk in options trading is the fact that you could lose all your money in options trading very quickly. Well, many people lose all their money in stock trading too, so what makes losing all your money in options trading such a big deal? The fact is, investors only lose all their money in stock trading when the stock they buy becomes bankrupt which has a very low possibility of occurrence whereas the possibility of losing all your money in options trading is extremely high and can occur within an extremely short timeframe.
So, does that mean options trading is risky and should never be undertaken like what so many people in investment forums suggested?
First of all, lets explore what about options that made it possible to firstly, lose all your money and secondly, within a short time frame.
Options are derivative instruments which derives its value from the price of its underlying asset. It do not have value of its own upon expiration. A call option giving you the right to buy a stock at $10 only has value if the underlying stock is above $10. If the underlying stock is below $10, you are already able to buy the stock at lesser than what the call option allows you to from the open market and the call option thus has no value. When this situation occurs at expiration, the option would “Expire Out Of The Money” with no value left and you will lose all the money you used for buying those options. This is one of the most common way beginners lose all their money in options trading; By buying options with all their money as if they are buying stocks.
Secondly, options have definite expiration dates. Unlike stocks, you can’t hold on to a losing options position forever. Options have a definitely expiration date and if you buy options with too few days left to expiration and no time left to move as predicted, you would lose all your money very quickly even if the underlying stock moved as predicted eventually. A lot of beginners buy options with too few months left to expiration due to the fact the more months left to expiration, the more expensive the option becomes. As such, a lot of beginners make the mistake of buying options that expire very soon and then lose all their money very quickly.
As such, options trading can be risky and you can lose all your money very quickly in options trading if you buy options with all your money with too few days left to expiration. As such, when you buy options, make sure you buy options only with money you can afford to lose (maybe 2% or 5% of your total fund size) and make sure you buy with enough time to expiration (maybe 3 months and more). When you follow these two simple rules, you will be able to avoid the situation in which you lose all your money in options trading very quickly.
