Options trading often comes across as a high-stakes trading style in the investing space. It’s exciting, fast-paced, and full of strategy. But before you jump in with money in your mind, it’s crucial to understand one thing.
Options trading is risky – to the point where you could lose all your money in a single day.
That doesn’t mean you should avoid it entirely. In fact, with the right knowledge and tools, options can be a great addition to your investment portfolio. Just make sure to go in with your eyes wide open.
What Is Options Trading?
An option is a contract that gives you the right, but not the obligation, to buy or sell an asset. Usually a stock, you can buy or sell it at a set price before a certain date.
The two main types of options are:
- Call options, where you bet the stock will go up.
- Put options, where you bet it will go down.
You can either buy options or sell them. And that’s where the risk starts getting high.
To begin, you need an options trading platform or broker that is approved to provide these services.
High Leverage, High Losses
Options offer a high degree of leverage, meaning you can control a large amount of stock with a relatively small investment.
Now, this approach works great if your prediction turns out to be right. You can earn huge amounts of money. But if it’s wrong? Well, you could lose all of your money and be left with an empty account.
So, while leverage increases your earnings, it also amplifies your losses.
Time Decay
Options are not forever. They expire. And as the clock ticks closer to expiration, their value decreases. This decrease happens even if the stock price hasn’t moved.
This is called theta decay, and it can quietly eat into your profits if you’re not paying attention.
Volatility Risks
While volatility creates opportunities, it’s also a contributor to unpredictability. A stock might go up or down quickly, making it difficult to react fast enough.
High volatility can also inflate option prices, making it harder to break even.
Unlimited Loss Potential
If you’re writing options, especially uncovered calls, your losses can technically be unlimited.
Imagine selling someone the right to buy a stock from you at $50, and then the stock shoots up to $500. You’ll owe the difference.
This is why your choice of a reliable trading platform, like SoFi, matters. A good one will not only offer tools and charts but also educate you on risk management and offer clear warnings when you’re entering high-risk trades.
How to Manage Options Risk
While the risks of option trading may be significant, they also apply to almost all types of trading. Putting money into something and expecting a return always comes with a degree of risk.
However, you can control or manage the risk with:
- Risk management tools
- Understanding complex strategies
- Consistent practice
- Demo accounts
- Smaller steps that gradually grow bigger
- The right trading platform
Options trading isn’t inherently bad. It’s just not for everyone.
