Over 40 Years of Options Trading – The Opportunity, Risk and Reward Potential
In the 1970’s when Options were launched on the Chicago Board Options Exchange there were only a handful of stocks that traded options and usually the options series expired quarterly. We’ve come a long way regarding options trading in the last five decades.
Today’s Expanded Options Market
Today, there are thousands of companies whose stocks also have options and many of them have weekly options expirations. For traders who understand risk management, this is a literal smorgasbord of opportunity to create income from options trading. In this article, we’ll discuss the opportunity, risk, and reward potential of two weekly options expiration strategies, and why it’s so exciting for traders and risk managers.
The Opportunity
The word option literally means choice. The more choice you have, the clearer you can understand the possibilities of risk and reward. Options are instruments which share many of the identical characteristics of insurance contracts. When you buy the options, you have limited risk and unlimited profit potential. When you sell or create the option, you are creating an obligation that you will be required to fulfill unless you liquidate the position before the options expire.
The Opportunity for Traders
Recently we published a beginner series in options trading which explores the basics of these fascinating instruments. You can access those articles here: Options Trading for Beginners – Part 1Buying Call OptionsOptions Trading for Beginners – Part 2Buying Put OptionsOptions Trading for Beginners – Part 3Selling Call OptionsOptions Trading for Beginners – Part 4Selling Put Options
Reasons Weekly Options are Exciting for Traders
There are essentially two reasons that Weekly Options are incredibly exciting for traders. First off, they offer tremendous leverage for option buyers. For example:
Let’s assume that Apple ($AAPL) is trading at 170. If you were to purchase 100 shares of Apple it would require that you come up with $170 x 100 shares = $17,000. In comparison, an Apple at the Money $170 Call Option with only 5 days left to trade might be trading at $3. This means that for $300 you control 100 shares of Apple stock.
Options Trading Strategies
But now let’s look at how the call option buyer in this transaction will evaluate the purchase of the call. Buying 1 March AAPL 170 call at $3, for example.
There are a couple of important considerations that we need to make clear for the options buyer:
- Probability: The probability of the market closing above the strike price over the next 5 days must be determined. Options are deteriorating assets and since they have a definitive expiration date, we know quite factually that with all things being equal an option will be worth less tomorrow than it is today.
- Time Decay: What this means is that all options suffer from something called time decay – the traditional way that an option premium expires.
Trading Weekly Options as a Highly Leveraged Speculation
Now, for traders who are more aggressive and would like to swing for the fences, we can see the risk/reward profile of trading weekly options. As we can see in the graphic above, there is potential for huge rewards if Apple stock rises over the strike price plus the premium collected.
However, with time decay as an active participant (the red circle above highlights what they are having to contend with whenever they purchase an option), and a decreasing premium – day after day – it’s essential to consider time decay as part of your risk assessment before committing any assets to options trading.
Time Decay – The Silent Partner in Options Trading
Time decay is the silent partner that influences all options trades. As we can see in the graphic above, even with Apple closing right at the strike price – and we would still lose money due to time decay alone.
Managing Risk When Trading Weekly Options
As a trader, you get to decide whether you’re attracted to collecting premium or swinging for the fences and controlling a huge amount of stock for a very small premium. Should a big move unfold, you will understand the power and leverage of buying call options.
However, it’s also clear that understanding time decay, probability, and your own risk profile is essential before taking any trade. When evaluating any opportunity – whether short or long-term – it helps to consider your choices with respect to the following: Price is the only thing that matters when we are trading.
Whether you make money from a bull market, a bear market – whatever price can do one, it would be wise if you have it work for you – and not against your account – always.
With weekly options expirations, there’s never-ending opportunities to experiment with different strategies. What is paramount to success in trading is understanding probability, risk and your personal profile.
Applying Artificial Intelligence to Options Trading
How do you find those markets with the best risk/reward ratios out of thousands of trading opportunities? Useful knowledge – that’s what A.I. delivers. Its vital importance lies not so much in how the machine can deliver consistency but its ability for a human trader to make use of useful data.
Why Artificial Intelligence Matters
Stocks usually trend about 30% time – and this is just one example. The remaining 70% of the time, stocks are usually in a trading range – which doesn’t really support either long or short trades.
But with options trading – A.I. can predict those high probability trades that offer the best odds for success.
A good trader understands the importance of risk management – and why having a plan to address that is so important when trading any market condition.
Most traders would not get excited about collecting premium, watching it decay day by day. However this strategy – as unpopular as it might be- has proven an effective one over years with savvy traders exploiting this pattern all the time.
Conclusion
In summary, there’s a substantial risk of loss associated with trading – and only risk capital should be used to trade. Trading stocks, futures, options, forex, and ETFs is not suitable for everyone. The articles provided discuss how A.I. can enhance your performance and reduce risks when making investment decisions.
Important Notice
This article and the website are neither a solicitation nor an offer to buy/sell futures, options, stocks or currencies. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this article or website.
