Stan Freifeld

Options Fact or Fiction

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The Answers

1) Options are too speculative for the general public to trade and make money.

Fiction: Options are a very versatile product. While they can be speculative, they can also be used to hedge an existing portfolio, to provide a steady income, to diversify and spread risk, and there are also ways to use them to profit in any type of market. Also, even when options are used in a speculative way, the amount of risk can be predetermined and limited.

2) Seventy-five to 80% of options traders lose money.

Fact: The sad truth is that most options traders do lose money. The key is to learn more (which you're doing here at The Options Insider.com) and to work smarter and harder than the competition. In other words, there's a lot of competition in the options market and therefore, it's not easy to make consistent profits with minimal risk. However, it is possible, and you can do it.

3) Since 90% of options expire worthless, the best way to make money trading options is to do what the smart money (market makers) do, sell options.

Fiction: A 2005 study by the Options Clearing Corporation showed that 48% of option contracts are closed prior to expiration, 17% are exercised, and 35% of options expire worthless. The argument that market makers generally are short options is true.

However, think about what a market maker does. He trades with the public. Since most of the public is more comfortable buying options, the market maker naturally becomes short. You can be sure that if a market makers' inventory becomes too short, he will increase his bids to induce the public to sell options back to him. Being too short means not being able to sleep at night. Been there, done that.

4) Options trading is a zero-sum game, when one options trader makes money, another has to lose money.

Fact: When trading options, no money is created. So if you add up all the gains of winning options traders, it will equal all the losses of losing options traders. However, when you include stock trades and hedges in the calculation of the gain/loss, it is possible for total gains to be greater than total losses, or vice versa.

5) Being assigned on your short options position is bad.

Fiction: Generally, you will only be assigned if your short options are deep in the money and already trading like stock. Granted if you're not expecting the assignment, there might be a cash flow issue, but that can normally be resolved upon hearing of the assignment on the next business day. Also, there are some strategies, like selling puts for example, where the objective is to be assigned.

6) Claims of having an outrageously high (90%-95%) win rate can possibly be true.

Fact: Actually, with options it's very easy to put together trades that have a high win rate. But be aware, if a trade has a win rate of 95%, there may be a bomb waiting to go off in the remaining 5%, yielding an overall negative expectation for the trade. An example of this type of trade would be to sell short term deep out of the money puts on an index. You'll win most of the time, but when you lose, it can hurt big time.

7) If a stock is very volatile, then you should buy options since you can make money if the stock goes up or down.

Fiction: If only it was that easy! In a sense, options are priced by supply and demand, and in accordance with the markets prediction of future volatility. In other words, if the market predicts that a stock is becoming more volatile, the options will be priced to reflect that prediction. There is no free money in the options markets.