Is options trading risky? Like any trading, it can be.
But is options trading riskier than trading stocks? Absolutely not.
I always see this question in the comments of my YouTube videos.
However, there are ways to trade options so that they are much less risky than trading stocks.
Sometimes option traders lose money because they're too aggressive.
Trading too often and too aggressively will not help if they're trading a bad strategy, not hedging for black swan events and not optimizing their entries.
Some traders even believe that day trading will help them be profitable, but the fact is that day traders almost always lose a lot of money (studies have shown that 97% - 99.8% of day traders lose money, and the "lucky" 0.2% that didn't ended up earning less than minimum wage).
Check out this day trading study that analyzed 360,000 day traders and... 359,000 LOST money, an average of 15% a year.
Is there a better solution?
Yes, there is. Continue reading below:
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The best way for retail traders to be consistently profitable is by selling option premium and trading options.
By trading options and selling option premium, you can target a monthly return of about 2% to 4% a month, while also reducing portfolio volatility.
Here are the three things you can do to improve your trading and maximize your profits:
- Sell Option Premium and Use Ratio Spreads for Directional Trades
- Trade Small & Be Patient to Optimize Your Trade Entries
- Trade Spreads to Protect Against Black Swan Events
1. Sell Option Premium and Use Ratio Spreads for Directional Trades
The best way to earn a consistent return when trading is by selling option premium.
When you sell option premium, you BECOME THE INSURANCE COMPANY
You become the casino.
Would you rather be the gambler who's buying lottery tickets? Of course not.
You can also use debit call, and debit put, spreads to capture large directional moves in a security.
For example, if you believe that XYZ stock will appreciate in value, instead of owning the shares, you can buy an OTM debit call spread and then finance it by selling OTM put options.
Learn the options trading basics (whether it's options spreads or naked options).
Have realistic expectations to reduce options trading risk
To be successful when selling options premium, you should always have realistic expectations.
Even if you win ~95%+ of your trades when selling options and collecting option premium, it's possible to still lose money if your losing trades are larger than your winning trades.
To counteract this, it's important to buy options during periods when volatility is low. This will help reduce your overall portfolio volatility.
2. Trade Small & Be Patient to Optimize Your Trade Entries
When trading, it's best to trade small and be patient so that you optimize your trade entry.
Trading small is a great way to limit your risk.
If you're selling a put option, you should ONLY sell a put at a strike price that you'd feel comfortable taking ownership of the stock.
Unfortunately, I've seen many people trade too large.
It's also important to be patient - this skill requires training and experience.
When entering new positions, I'd rather be "too late" and miss a trade, then "too early" and be forced to deal with a bad trade.
It's important to not be greedy when opening new positions, you don't want to end up like OptionSellers.com
As long as you're dedicated to constant improvement then you can become a successful options trader.
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Being a successful options trader requires discipline.
Most people are not successful traders because they want to make quick money.
Quick money doesn't exist without taking substantial risk.
Traders should only trade large capitalization market leaders and large indices - this will help reduce risk.
3. Trade Spreads to Protect Against Black Swan Events
It's important to primarily sell defined risk, or vertical credit spreads, when trading (especially if you're trading an account below $20,000).
This is important because to protect your account against black swan events.
During market crashes, the market tends to act irrationally and become oversold.
Plus, volatility expands and all of your existing short puts may end up showing a loss.
It's important to hedge against sequence risk, by having too many of your positions be correlated, and minimize the possibility of being forced into a margin call.
The best way to do this, while also having your trades be more capital efficient, is to sell vertical credit spreads (and not naked options).
Conclusion: Is Options Trading Risky?
If you're looking to make consistent profits in the stock market, then selling option premium is the best strategy for you.
Selling options is proven in the real-world (as long as you protect your downside risk).
By selling options, you're turning yourself into an insurance company and behaving like a casino.
You can optimize your returns and minimize losses by trading vertical credit spreads, sizing your trades correctly and only selling puts on securities that you want to own.
You can also buy options when volatility is low to hedge your portfolio.
Is options trading risky? Yes, it can be, but it can also be very rewarding and profitable.
If you have any questions, leave a comment below. You can also contact me on my David Jaffee personal website.
Frequently Asked Questions (FAQs): Is Options Trading Risky?
What are the disadvantages of options trading?
The disadvantages of options trading is that options trading utilizes significant leverage. If you trade too large then you can be forced to close out positions at the worst time and suffer a large loss.
Also, trading during periods of low volatility, when options prices are low, is risky because if volatility expands then you can be placed into a margin call.
Options are leveraged products, as a result, it's important to protect yourself, at all times, against black swan events.
What are the pros and cons of options trading?
The pros are that you can earn significantly more money than by buying and holding stock (or other forms of investing) while also achieving a much higher win rate on your trades.
The cons are that you can't trade too large since options are leveraged financial products (meaning that you also have the ability to lose more money than when investing in stocks).
What are the benefits of options trading?
The benefits of options trading is that you can earn significant returns while mitigating your risk, if done correctly.
Is options trading risky?
Options trading can be risky if traders are not disciplined or they do not properly hedge their portfolio.
Oftentimes traders trade too large or engage in low probability trades that cause them to lose money.
Options risk management?
Options traders can easily manage their risk by not trading too large and buying options (both puts and calls) when they believe that the market is overbought or oversold.
Additionally, options sellers can make it a habit to use vertical credit spreads, and not trade naked options because defined risk trades (vertical credit spreads) will inherently protect traders from black swan events.
