Is Options Trading a Risky Business?

Most people consider options trading a risky business. While it is true that no investment is without risk, it is possible to limit or manage your risks, just as you would with any business.

If your option strategies are more like betting or gambling, if you follow some sort of intuition or sixth sense, then you will lose money. If your strategy is to think of options trading as a business and you know about managing a business or you are willing to learn, then you can make money.

Any business owner looks at the cost of goods and the potential profits to be made. In other words, what an item can be purchased for and what it can be sold for. Investments should be looked at in the same way.

A business owner must also be willing to look at how much loss is affordable and acceptable. There will always be items lost or broken during shipping. Someone is likely to drop that crystal goblet and break it before it goes into the box. But, when an item is simply too delicate to handle, there will be too much breakage, too much loss and a business owner will probably decide not to sell that item.

If you are new to the “business”, it is a good idea to learn the option strategies used by experienced investors. There are plenty of investors out there willing to teach you their system for a price.

There is a great deal of free information, too. But, this is truly one of those situations where you get what you pay for. No truly successful investor will tell you everything there is to know about his option strategies for free. Why should he?

But, before you buy a book or download an e-book on the subject of options trading, do a little evaluation. Ask some questions to make sure that you are not wasting your money.

First, is this a system that works, regardless of the economy? There are profitable option strategies that work regardless of the state of the economy. This is not like the stock market, although it is affected by it.

Second, is this a get-rich-quick scheme or real education about managing this kind of a business? Is the system based on business fundamentals, such as profit, loss, expenses, overhead and return-on-investment?

After reading this article, you should know what the answers to those questions should be. You are looking for an options trading business, not a scam.

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How Options Are Priced

Understanding how options are priced can greatly help you profit in today’s stock market. One of the biggest misconceptions about options is that they are 100% related to the stock’s price. This is not true, it is possible to buy a call option on a stock, the stock’s price goes up and the options price goes down.

That is because there are 2 different parts of an option. The first is called intrinsic value. This is simply the difference between the stock’s price and the options price. So if we buy a $90 call on a stock that is trading at $98 the intrinsic value is $8.

It would make sense for that option to be priced at $8. What you will find however, is that the option will be priced above its intrinsic value. The call might cost $9.5. The other $1.5 is the time value of an option.

This value gets its price based on how many days are left before the option expires. The downside of this is that as time goes by the lower the time value will go.

So, if that stock stays at $98 for a month the option price will have gone down even thought the stock’s price hasn’t changed. The time value will have probably gone down a lot by that time.

To make money on an option the stock must go up faster than the time value decays. Slowing down the decay of an options time value is just as important as finding a stock that is heading up. There are a few ways to do this.

1. Buy more time. Obviously an option 3 months away will decay at a slower rate than an option that will expire next week. Most professional traders will buy more time than they think they need to avoid time decay.

2. Buy an option with a lower strike price. The further in the money you buy an option the less time value and more intrinsic value it will have. Unfortunately the more in the money your option is the more you will pay for this option. But It helps to lessen time decay.

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