please help me settle an argument on options...

[ajizzle]

i am currently with a group of new hires studying for the series 7. One guy in my group thinks he knows everything about anything, and is convinced that making money on options is like taking money from a baby. My personal thinking is that, like most things, if it sounds too easy, then it's not realistic.

His argument: By buying an option, you have the potential to make a HUGE gain since your initial investment (premium) is heavily leveraged. Also, your potential loss is much smaller than actually longing the underlying security, because you can only lose your premium.

My argument is that options are zero-sum. For every dollar someone makes in options, there is someone on the other end losing that money. Since investing in the actual market has given a steady average return of X% over the last 70 years (dont know X), it's much easier to make a large sum of money trading securities as opposed to options.

I compare it like poker, although I may be way off base here. Although i have no actual experience in handling options (just studying for 7 here) i imagine that the vast majority of people lose a little bit of money(like 70%), a few people make a little bit of money(like 25%) and only the best of the best make a lot of money in options, just like poker.

His perspective sounds like someone who believes they will clean up any 80/160 game after reading HPFAP. Please either correct me, or help me explaining this to him. Thanks

[Tweety]

I tend to agree with you.

In my trading career, I have generally either lost money in options, or made less than I felt I should have made by simply owning the underlying instrument outright.

The people I know who have been successful trading options use them more for hedging, and have a good feel for value in a pricing.

But I agree- unless you're a real expert, stay away from them.

[iversonian]

You're right. I don't think you need any help understanding options enough to explain it sufficiently to him.

[Tater10]

Slot machines: small investment with potential to make HUGE gains - how can you lose?

Does your friend realize that people actually sell the options to the buyers? Who gives their money away?

Market in any given option might be 4.25 bid at 4.30, thousand up, why aren't the 4.25 bids just buying the 4.30s, if there is so much profit to be made?

[Jcrew]

Monetary terms, trading options is zero sum or negative if you include commissions. However parties have different risk tolerances and trading objectives so it possible that a trade is net positive utility.

Deciding what is better depends on your trading objectives and your risk tolerances. Options are great for speculation and hedging.

[UrmaBlume]

A relavant fact about options is that most expire worthless.

On paper have your buddy pick a few options. On paper short those options to your buddy. See who is ahead in a month. Doesn't matter whether they are puts or calls.

[Tupacia]

Urma is right, multiple studies have shown that buying options is a sucker's play on a general scale (negative returns historically) whereas writing options has produced a profit. Now obviously, there are people who make a lot of money buying options and people go broke everyday writing them, but people tend to overpay for options as most expire worthless.

Also, his argument about limited risk unlimited reward is basically the same as buying a lottery ticket. "My risk is just $1 and my upside is millions and millions of dollars! "

[JJay1231]

[ QUOTE ]
One guy in my group thinks he knows everything about anything, and is convinced that making money on options is like taking money from a baby.

[/ QUOTE ]

judging by his comment he knows absolutely nothing about trading options.

Options trading is much harder than trading other investment vehicles because of the fact that not only do you have to pick the right direction, but you also need to factor in "volatility" which is a very important consideration when trading options. If you get into a discussion on options with somone and they dont mention "implied volatility" you can rest assured they are completely ignorant on the subject.

If you buy options and pick the right direction, it is still possible to lose money on the trade because of Implied volatility, thats how important it is.

You are right that options trading (like Futures) is a zero sum game, but there is money to be made in options IF you actually know what you are doing.

"Buy low, sell high" (volatility that is [img]/images/graemlins/smile.gif[/img]) and have a very firm grasp on Technical Analysis and it is possible to do well.

(and yes I traded options for 2 years, but just stocks now. May look to trade them again in the future)

[pig4bill]

[ QUOTE ]
Urma is right, multiple studies have shown that buying options is a sucker's play on a general scale (negative returns historically) whereas writing options has produced a profit.

[/ QUOTE ]

Cite one of those studies.

This is one of those urban legends that's often quoted but never seems to have any proof behind it.

[mrbaseball]

[ QUOTE ]
This is one of those urban legends that's often quoted but never seems to have any proof behind it.


[/ QUOTE ]

Yeah [img]/images/graemlins/smile.gif[/img] Options being zero sum means there is a seller for every buyer. There are puts and there are calls. If the put expires worthless the call doesn't (and visa versa) unless you pin the strike.

Most out of the money shots do expire worthless. But out of the money shots are only a portion of the options universe and the speculators and novices generally only refer to out of the money longshots.