Is options trading risky?
I always see this question in the comments of my YouTube videos.
People express concern about options trading by indicating that selling options is “picking up pennies in front of a steamroller”, and comment that “selling option premium is risky”.
However, there are ways to trade options so that they are much less risky.
Traders often lose money when selling options because they're too aggressive. Traders mistakenly believe that trading too often and being aggressive will make them money.
Trading too often and 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 (a recent study indicated that 99.8% of day traders lost 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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In my opinion, the best way for retail traders to be consistently profitable is by selling option premium.
By selling option premium, you can target a monthly return of about 2.5% to 3% a month, while also reducing portfolio volatility.
Here are the two things you can do to improve your trading and maximize your profits:
Trade Small & Be Patient to Optimize Your Trade Entries
Trade spreads to protect against black swan events
1. Sell option premium to Reduce Risk
People who tell you things like selling premium is "picking up pennies in front of a bulldozer" do NOT understand how to hedge when trading options.
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.
When trading options, it's also important to hedge your positions. We'll discuss that more later in this article.
Learn the options trading basics (whether it's options spreads or naked options).
In my article about the 3 hard truths you must know about options trading, I discuss some vital information that you'll need to be consistently profitable.
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.
"People who tell you things like selling premium is 'picking up pennies in front of a bulldozer' do NOT understand how to make money in the stock market." - David Jaffee, BestStockStrategy.com
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2. Trade Small & Be Patient to Reduce Risk
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 don't have much experience.
Also, you should never stop learning, no matter how much you already know. There are many ways you can learn about options trading: books, articles, podcasts, courses, videos, etc.
As long as you're dedicated to constant improvement then you can become a successful options trader.
It's important to not be greedy when opening new positions, you don't want to end up like OptionSellers.com
Being a successful options trader requires discipline.
Most people are not successful traders because they think that they can make quick money.
Quick money doesn't exist.
Traders should only trade large capitalization market leaders and large indices - this will help reduce risk.
Also, do not sell puts on any companies that you do not want to own.
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- Learn how to earn consistent profits in the stock market while also reducing risk.
- Step-by-step education course teaches you everything you need to know and caters to ALL traders of all experience levels (absolute beginners through advanced traders)
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3. Trade Spreads to Protect Against Black Swan Events
It's important to mostly sell defined risk, or vertical credit spreads, when trading.
This is important because you need 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 short puts, when sold during periods of low volatility, may end up showing a loss.
As a result, 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 acting like a casino.
You can optimize your returns and minimize losses by being disciplined and patient (and by not trading too large or being greedy).
Also, you can trade vertical credit spreads, and also buy options when volatility is low to hedge your portfolio and reduce the volatility of your returns.
By learning to be disciplined and optimizing your opening trades, almost all of your trades can be profitable.
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)
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 easily lose money since options are leveraged financial products.
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.
