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Advantages and Disadvantages of Stock Options Trading.

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

What i don't like about options is that are a decaying asset, the time value of the price gradually diminishes as the option approaches expiration, at which time it becomes zero.

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I would rather say option comes with a high risk and return profile. In simple words, the person who shorts the options takes the maximum risk and his profit is limited compared to the Long party in option with a risk-return profile of limited loss and unlimited gain.

 

Apart from this, the worst part in option is it's a zero sum money. It means that it's not creating any wealth in the market. It's simply a loss to one party compared to profit to the other one.

 

 

This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

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One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

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One other advantage of options trading is hedging. Options can be used as a hedge in your stock portfolio.

 

So here is a review of advantages and disadvantages of options trading.

Advantages:

Leverage.

Hedging.

 

Disadvantages:

Decaying asset.

High risk and return profile.

Zero sum money.

 

Here in lies the great/confusing part of options. what is one persons advantage may be the others disadvantage.

 

Add

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

various strategies can be used across months and strikes.

can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

zero sum - if you are constantly loosing and have no way of offsetting this

various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

Limited Downside - if short options

 

Bascially - there is a lot options can offer, and there are a lot of advantages and disadvatanges and these differ greatly on if the options used are long, short, puts, calls, naked or covered.......you cannot be general with them.

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Thank you for your reply SIUYA, you are right, most of the times the advantages of options for some traders are disadvantages for some other traders and you are right that you can't be general with options. Your post was very helpful. So here is how our list looks like now:

Advantages:

Leverage - requires good risk controls

Hedging

Decaying asset - when you are short

Zero sum - if you are constantly winning.

Various strategies can be used across months and strikes.

Can be used as part of a portfolio hedging strategy

Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)

Limited Downside - if long options

Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

Excessive leverage when risk controls are poor

Hedging is often misunderstood and the hedge may in-fact merely change the risk profile but not actually act as a hedge

Decaying asset - when you are long

Zero sum - if you are constantly loosing and have no way of offsetting this

Various strategies can be used across months and strikes -dangerous if you dont understand what you are doing

You might not have enough capital/assets to effectively implement a portfolio type strategy

Unlimited downside - if short options, (subject to expiry, and if put or call)

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This thread is for those wishing to discuss the advantages and disadvantages of stock options trading. I am waiting your thoughts..

 

One positive for stock options trading I believe is leverage, with options you can achieve a greater amount of leverage than when purchasing the underlying stock.

 

Trading in binary options has increased substantially in recent years. In an earlier era, binary options trading had to be done through a specialized broker who charged high fees for the service. Today, people can visit a binary trade website and process the transaction themselves, making it both simpler and cheaper to trade binary options for fun and profit.

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

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Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

 

Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

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Hmm I am not sure about the stock then. Rise in stock price does not necessarily create wealth specially tangible one. Specially when it rises on speculation and bubble is burst. It surely does have losers and winners both. May be not as clear cut as options but still...

 

stocks are generally not thought of as a zero sum game. The main reasons being that stocks have a limited number of shares issued at any one time, they usually represent a claim over some assets or cash flow (eg; supermarket, banks profits). They can actually generate wealth.

Futures and options on the other hand merely require a buyer for every seller and these are viewed as a zero sum game......much like insurance.

 

see Zero-Sum Game Definition | Investopedia

see wikipedia for more info....

eg"Many economic situations are not zero-sum, since valuable goods and services can be created, destroyed, or badly allocated in a number of ways, and any of these will create a net gain or loss of utility to numerous stakeholders. Specifically, all trade is by definition positive sum, because when two parties agree to an exchange each party must consider the goods it is receiving to be more valuable than the goods it is delivering. In fact, all economic exchanges must benefit both parties to the point that each party can overcome its transaction costs, (or the transaction would simply not take place).

"

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Zero sum basically means someone is losing that is why the other one is winning. In simple words, options (Derivative trading) do not create wealth where as stock (trading in cash market) creates wealth for all the investor.

 

This is fundamentally FALSE. The stock market is a market. The reason why prices go up on any stock is because buyers are willing to pay higher prices. Simple as that. Someone has to sell the stock to a buyer. So if a stock price has gone up for the last 25 years it is only because buyers chose to buy higher each year. Why would buyers collectively do this? For many reasons. It could be because they think that the company is undervalued. Or they perceive that the company will create or develop a new idea or technology. Companies simply do not reward you for staying with a company for many years through the payout of an increase in what you paid for the stock. No they reward you with dividends. Other buyers reward you not companies. A company is only worth what someone will pay for it.

 

The price of a stock is not directly tied to the value of the company either. It could be but only if buyers collectively use that. I would like to point out that at the peak of the last financial crisis there were many banks that suffered a loss on their stock price. The reason for it was the fact that they were banks and a majority of banks had problems. The entire financial sector suffered regardless if the company was or ever was involved with any sort of mortgage loans. This is similar to the housing market. If you have the nicest house on the street and a few houses on your block or in your area are run down then it diminishes the value of your house.

 

Here is an example of your fallacy. If you would of bought 10 contracts of ES a few years ago when it was at 700 and then sold it today at 1517 you would be up. So based on your example the ES generated wealth. And this is based on a supposed index of more then 1 company. Given the example so far the ES seems to be a better form of generating wealth. Also you can short sell stock. This in effect is similar to a futures trade in that you are not required to "own" something before selling it.

Edited by Colonel B

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Let me explain you in simple words, Suppose you have bought the Apple's one share 10 years ago at $10 and you sold the same after 5 years down the line at $20. You made a profit and its natural that somebody has bought the same from you at $20 (5 years ago). Now the current market price is $30, then he can sell the same and can make a profit. In this sense wealth is created in stock market, not in Derivative market but it depends upon the company's performance and how much income they are generating and their growth prospects.

'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

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'Hi Larry, I understand your point. However I am making much more broader view based on the fact that no company grows forever, every company will go up and down. Lets stay in that respect, stock follows the pattern. No stock will go up forever, it will eventually go down. There are winners on the upward motion and losers in the downward motion. In that sense it is also zero sum. There is really not a wealth created here. No coin is being printed, no tangible product is being created when stock price goes up. It is just price is going up like a product. Just like a gas price. You cant say the wealth is being created when the price goes up. Sellers of gas gain and take advantage by of higher gas with higher revenue where a consumer suffer by paying more. and vice versa when the gas price falls down.

 

I guess you have interpreted wrong my friend. I made the comparison between stocks and Derivative market.

 

Before answering the question, "Do stock market really create wealth" ?

 

Let us first understand the nature of stock markets. A stock market is a place where people can buy and sell their shares in companies. The price at which they buy and sell is determined by demand and supply of shares at that point in time. In other words when marginal demand for shares is plentiful relative to marginal supply, prices will rise and vice versa. The key to stock market prices is marginal demand and supply. People who buy and hold shares for the long term ensure that marginal supply does not increase thereby keeping a floor under prices until they decide to sell. As long as buy-and-holders keep buying, we can safely assume a rising floor for prices. Once they decide to sell, the floor collapses.

 

Company profits have a role in influencing stock market prices i.e. in attracting people to buy the company’s shares. A company with a long track record of rising profits attracts a large number of buy-and-holders thereby reducing the stock’s marginal supply while simultaneously increasing marginal demand which effectively raises the price floor. Profits may be real or created by accounting manipulations. Both have the same effect on stock market prices.

 

Unfortunately, people forget that a track record of rising profits (either real or illusory) is unsustainable and has to break at some point in time. Profit disappointments cause the price floor to break. Once broken, it is near impossible to stop from going down significantly at a pace determined by the buy-and-holders. Real profits erode slowly while accounting illusions disappear rapidly. Hence the decline of really profitable companies is slow whilst it is rapid for those companies whose profits are illusory.

 

Wealth is measured as an increase in nominal net worth. As long as stock prices rise, your wealth increases while it decreases when stock prices fall. It is clear that you have exit at the right time for your wealth to sustainable increase. Exiting at the right time requires a lot of ability and luck.

 

There are investors who have held stocks for decades and have generated tremendous wealth just by holding on to those stocks. The key reason for this growth in stock market wealth is the massive increase in money supply. As long as money in the system remains constant, price rise in one stock is usually accompanied by fall in another as money to buy can be generated only by selling. This would ensure that the market cap of the stock market remains constant. But if money in the system increases, buying can be done without selling thereby raising the overall market cap. Unfortunately, we have lived in an inflationary world for so long that people have come to accept it as a natural reality rather than a political choice. This has lead to the belief that stock markets always rise in the long run and equities generate tremendous wealth.

 

But on the other hand, Derivatives never generate wealth. I hope this is clear.

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I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

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I think one of the biggest advantages of trading options is that they give you the flexibility and ability to create complex positions that would not be possible if you only traded the underlying. Even a short vertical spread gives you some pretty cool things: it can make money if price moves, doesn't move, or only moves against you a little bit.

 

You can also construct positions that move in your favor more as they move in your favor and go against you less as they go against you. Both seem pretty desirable.

 

Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

  • Leverage - requires good risk controls
  • Hedging
  • Decaying asset - when you are short
  • Zero sum - if you are constantly winning.
  • Various strategies can be used across months and strikes.
  • Can be used as part of a portfolio hedging strategy
  • Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  • Limited Downside - if long options
  • Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  • Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

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Thank you for your reply ThetaTrend, your post was very helpful. So here is how our list looks like now:

 

Advantages:

  • Leverage - requires good risk controls
  • Hedging
  • Decaying asset - when you are short
  • Zero sum - if you are constantly winning.
  • Various strategies can be used across months and strikes.
  • Can be used as part of a portfolio hedging strategy
  • Unlimited upside - if long options, and you can run them (subject to expiry, and if put or call)
  • Limited Downside - if long options
  • Flexibility and ability to create complex positions that would not be possible if you only traded the underlying
  • Dividend and corporate strategy plays - dependent on local laws

 

Disadvantages:

 

Adding to your point, Options are really useful for hedging. If the trader has the knowledge of option Greeks (mainly delta and gamma) then they can use the same and easily manage their risk and return profile.

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Options basically created for hedging and soon speculators jumbed in to make some extra profits in the new market. Greeks are useful tools in the hedging procedure.

 

We all know that options were earlier introduced for Hedging but due to its payoff profile, it attracts traders to come. Options is equally traded by arbitrageurs as well.

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I believe that today most of the participants in the options markets are speculators, hedgers are the institutionals investors and hedge funds.

 

Don't forget Arbitrageurs, they are also one of the big market participants. They play in big volumes, but frequency is less.

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Wth options you can take a position with very low capital requirements. A trader can do a lot in the options market with $1,000 but not so much with $1,000 in the stock market.

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    • Date : 25th October 2021. Market Update – October 25 – Big Earnings Week Ahead, USD Cooler. USD (USDIndex 93.50) cools a tad & again tests 4-wk low (93.44). PMIs biased to the upside as Powell talked taper but no rate rises yet, Democrats narrowed their differences on the $3.5b infra bill & Yellen talked new taxes. Yields hold up, Equities mixed Friday, FUTS down. Big week for Earnings – Oil up again on supply concerns, gold back to $1800. Evergrande – Restarted 10 building projects over weekend, announced move away from real estate towards EV production. US Yields (10yr closed higher at 1.665) & – now 1.6500% Equities mixed – USA500 -4.88 (-0.11%) at 4544 (NASDAQ –0.82%) – Big movers – SNAP -26.59% & INTEL -11.68%; Big Earnings misses, FB -5.05%, GOOGL & AMZN –3%, TSLA +1.75% – USA500.F back to 4540. Asian equities weaker. USOil up again on supply concerns & trades close to 7-year highs at $83.00 Gold very volatile Friday ($1782-$1813-$1793 on close) Back to pivot at $1800 now. FX markets – EURUSD 1.1650, Cable 1.3770, & USDJPY – (after a strong day on Friday (113.40 low) now at 113.60. Week Ahead Earnings from 5 x tech giants (FB today), plus major European Banks. Policy meetings from the ECB, BoJ & BOC, economic data includes US Q3 GDP & PCE. Plenty of CB speak, the UK Budget and month end too. European Open December 10-yr Bund future up 23 ticks at 168.51. DAX & FTSE 100 futures up 0.15% & 0.25% respectively. Inflation risks remained in focus as oil prices continue to climb higher while bottlenecks in supply chains lead to rising cost pressures. The combination already weighed on manufacturing PMIs last week & are likely to also depress the German Ifo confidence reading today ahead of Thursday’s ECB meeting. Fed Chair Powell signalled on Friday that inflation could stay higher for longer & that the taper is coming. ECB by contrast has pushed decisions on PEPP & APP back to the December meeting, which means this week’s ECB will be watched mainly for signals from Lagarde at the press conference. TToday – German IFO and BoE’s Tenreyro. Earnings: Michelin, Facebook, Restaurant Brands. HSBC surprises with 74% rise in Q3 profit and $2bln buyback. Biggest FX Mover @ (06:30 GMT) AUDJPY (+0.45%) Recovering from a strong day run fro JPY last week. Up from 84.50 tlow on Friday to test 85.00 now. Faster MAs aligned higher, MACD signal line & histogram rising, RSI 51 & neutral. H1 ATR 0.189, Daily ATR 0.817. Always trade with strict risk management. Your capital is the single most important aspect of your trading business. Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HotForex Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Stuart Cowell Head Market Analyst HotForex Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
    • Date : 21st October 2021. Market Update – October 21 – Stocks & USD slip on big Earnings Day. USD (USDIndex 93.55) cools a tad and again tests 2-week low (93.47) Yields stronger again, Equities closed up, but FUTS are down (Nikkei -2% on stronger YEN and Yuan). Big day for Earnings – TESLA beat but revenue numbers disappointed some. Oil up on drawdown. Evergrande – Bad News $1.7bn sale of 51% of HK unit to Hopson OFF, $1.7bn sale of HK HQ OFF, $83.5m coupon default triggers tomorrow. Good News $260m bond coupon, extended by 3 mths US Yields (10yr closed higher at 1.63) & – now 1.6533% Equities moved ground higher USA500 +16 (+0.74%) at 4536 (NASDAQ –0.05%) – Big movers – Verizon +2.41% & ABBT +3.3% (PayPal – 4.91%) – USA500.F back to 4500. Asian equities weaker. New VIX contract at +1.49% at 19.60 USOil up on drawdown n strong demand at $82.00 after EIA inventories showed -400K vs build of 2.1m Gold holds at 4-day highs – $1785 FX markets – a recovering USD – EURUSD 1.1646, Cable down from 1.3830+ to 1.3800, & USDJPY – off 4-year highs and pivots at 114.00. European Open The December 10-year Bund future is down -16 ticks, US futures are also in the red. DAX and FTSE 100 futures are both down -0.45 and US futures are also in the red, with the NASDAQ underperforming again, after already closing slightly lower yesterday. Indices remain at high levels, but tapering concerns, the global energy rout and supply chain concerns are capping the outlook for global growth. Markets will continue to watch earnings reports and central bank comments, especially in the UK where officials clearly are laying the ground for an early lift off. Meanwhile the announcement of Weidmann’s departure has raised hopes that the ECB will push even more to circumvent the no-bailout clause permanently – after the end of PEPP, which already helped BTPs to outperform yesterday. Today – US Initial Jobless Claims, Philadelphia Fed Business Index, Existing Home Sales, EZ Consumer Confidence, EU Council Meeting, Fed’s Daly, Waller, RBA’s Lowe, Earnings: AT&T, Intel, American Airlines, Southwest Airlines, ABB, (bottleneck problems) Vivendi, Hermes, (beat) Pernod Ricard,(beat) Barclays, (Revenue big beat) Unilever (Sales miss). Biggest FX Mover @ (06:30 GMT) AUDJPY (-0.50%) Rejection of 86.25 this morning as Yen lifts after a very weak October. Faster MAs aligned lower, MACD signal line dips and & histogram slips significantly lower, RSI 40.00 off OS level, H1 ATR 0.189, Daily ATR 0.817. Always trade with strict risk management. Your capital is the single most important aspect of your trading business. Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HotForex Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Stuart Cowell Head Market Analyst HotForex Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
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    • Nice article send in here, do sharing other such articles and also share your experience of Forex Trading.
    • Never tried Forex Trading with software,  I am still learning. But someday, I would like to give it a shot. 
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