Posted on 28 September 2011.
Trading options for dummies is not as easy as it sounds. Naturally, anybody with the requisite amount of capital to risk can play on the options market. It is important to recognize that options trading is a counter-intuitive investment vehicle that requires the trader to place his bets contrary to the consensus of market wisdom, in order to make any money.
If, for example, everyone expects Stock ‘X’ to rise in value from forty dollars to seventy dollars in the next six months, a futures contract would seem to be a guaranteed winner. This is not really true, unfortunately. If everyone expects the stock to rise thirty dollars, then a contract that hits that target is likely to yield just about nothing in profit, since everyone else is placing the same financial bet. The key concept to trading options for dummies is that one has to place a bet on something that the market does not expect to happen, in order to make any significant amount of profit on the transaction.
Since most amateur investors lack the necessary detailed analysis of worldwide trends that might make an informed options strategy possible, it needs to be recognized that this is often a form of gambling, rather than a form of investing. Like any form of High Risk, High Reward activity, the returns can be amazing. The losses can be incredible as well. For most small, individual investors, the only place in which options trading possibly belongs in a portfolio is in a case where short options are used to guard against temporary market fluctuations.
In these situations, savvy investors use short plays to guarantee their profits by taking a small option payment up front as opposed to leaving a position exposed to the wild swings of the current economic climate. Trading options for dummies is only a sound strategy when the purpose of the trade is to obtain certainty, as opposed to spinning the roulette wheel of fortune.
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