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As soon as a trader enters the world of Options the first thing that comes in their mind is to buy options.
These are the reasons they start off by buying options as told by brokers, or friends or reading in websites:
1. Option buy has low risk – It is a myth. Agreed you can buy an option for less than 100 rupees but do not forget that it does not guarantee that it will make money. That 100 rupees can become ZERO. There is no business in the world where you buy something then there is a possibility of losing 100% of the money on it. Low risk if combined for one year can be very high risk. Ask any three year experienced option buyer how much he lost. I bet the average will be more than 1 lakh rupees.
Low risk is to lure option buyers to buy options.
2. Option buy has unlimited profits – This is only in theory. Have you ever heard of an option buyer who started with 500 rupees and went on to make 5 crores. Unlimited profit right? so why stop at 5 crore, why not 10 crore or even 100 crore?
Nobody has ever done that, no one will ever do that.
In reality option buyers book profit at some stage. This they call as target. There is nothing wrong in keeping a target for stop loss and profit because this is how this business is done, but then when there is a target to book profits and exit where does the word unlimited come from.
Beware of this myth of limited loss unlimited profits of buying options.
3. Best option trade in the world is to buy both at the money call and put because if the stock moves down out will make money and if the stock goes up call will make money – This is actually one of the worst option trades in the trading history.
In that case why not every option buyer does that? I mean buy both calls and puts of the same stock and keep laughing all the way to the bank every month?
Why this does not make money?
Do not forget that options do not come for free. What an option buyer pay for is the premium built inside the options.
At The Money options have the maximum time value built in them. And statistics suggest that most trading is done in ATM – at the money options, which has the maximum time value.
Last 10 days time value of options evaporates like melting ice. Time value evaporation means money getting evaporated in the sky. This is like throwing money.
Greedy traders who want to take advantage of movement in last 10 days actually buy options during last few days only. Imagine the kind of risk they are taking. It is like putting their money on fire.
Sure sometimes option buyers get lucky here and there, but long term they lose money. The real reason is written above – options slightly overpriced compared to the expected move of a stock. Overpriced means Theta and Vega is added to their pricing.
I hope now it is clear why most of the times option buyers lose money even if they buy both long calls and puts.
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Dilip Shaw, Founder
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