Why is Options Trading so Risky?

Risk is the key element that deters investors from exercising stock market instruments. Those who have a low risk profile, they usually shy away from stocks, no matter how huge are the profit making possibilities. Talking, exclusively about stock market instruments’, trading is based on greed, fear and sentiment. Traders, big or small, have the sole purpose of making quick capital gains. Options are traded for the reason that they offer the opportunity to multiply invested sum on day to day basis, but the risk is so high that investors can lose every single dollar they invest.

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Losses occur while trading stocks too, but they cannot be compared to the magnitude of losses which an investor can face while trading options. In this post, we will evaluate a number of risk possibilities faced while trading options.

Although, we are discussing the risky nature of trading in options, but that doesn’t mean that one should not trade in these instruments. Despite the long list of possible risks and challenges they bring along, options are the ideal instruments for placing hedges against stocks holdings and future contacts.

Trading in Calls and Puts

Options are derivative instruments that have a fixed expiration date, so the position automatically closes, even if the investor is not willing to do so. One can buy a call option if he feels the price is headed north or else he can opt for a put option, anticipating a fall. If an investor fails to correctly predict the value of underlying asset on expiry, he loses his entire investment amount. For instance, if you predict that a stock will close above 1000 at expiry and it is currently quoting at 950, then you buy a call option for 1000. Now if the stock closes above 1000, then you make profit, but if it fails to do so, then you lose your invested amount. Options can fluctuate with immense volatility nearing expiry week, hence it becomes almost impossible to trade in them.

Key Risks faced by Buyers in Options Trading

• Losing invested capital in a very less time frame, making it difficult to manage or avoid risk.
• Options keep shredding value with each passing trading session, as the hedges start rolling over to next expiry.
• Each option contract may have different exercise provisions, which may increase risks for individual investors.
• At any point, regulator may interfere and lay exercise restrictions, which may result in prohibiting the buyer from realising value.

Options Writers carry Even Higher Risks

• Such trades can get exercised much before the expiry if the margin limit gets triggered.
• Traders with covered call position continue to make losses if the value of underlying stock increases above the strike price. Such losses can be indefinite in nature.
• Those who have a naked sell position in a call or a put option bear the risk of unlimited losses.
• The leverages are so high while writing calls and puts that the losses can be much higher than the short sellers in the same securities.

Trading Options bear enormous risks and that is the reason why these should be traded by seasoned investors only.

Read More:-

Understanding Call & Put Options – Learn Effective Options Trading

Learn to predict stock price movement

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