Give it to me straight: the advantages and disadvantages of options?

[TAjammy]

i'd really like to know this, because they seem too simple, too 'safe'. the fact that you are completely safe with a call option (bar the loss of the premium) if a stock/currency/future etc gaps down 99.9% overnight.

advantages and disadvantages- go!

 

[Masquerade]

Advantage: Very few people understand how they're priced.
Disadvantage: Very few people understand how they're priced.

 

[tenbobtrader]

I got as far as above

next

 

[N Rothschild]

majority of options expire worthless. your better off writing options but thats for the advanced only not a demo trader

 

[tenbobtrader]

expire

wot about the bit in the middle ?

 

[N Rothschild]

well depends what your doing with them, if its a euopean style option you want to execute expiring worthless is a big deal! just saying writing options will actually play out better in the long term.

as for the in the middle bit, unless you get a huge move into the money there is little advantage of using optioms over futures IMO

if your holing call options and the market moves 400 points over a few weeks your going to make f all coz of the time decay, with a future you will make the same profit no matter what. now if that market moved 400 points in an hour then yes options would be better! but predicting when and where a market will be is a tad trickey..most people cant even master what direction it is going to go, let alone how fast it will move there

 

[Martinghoul]

i'd really like to know this, because they seem too simple, too 'safe'. the fact that you are completely safe with a call option (bar the loss of the premium) if a stock/currency/future etc gaps down 99.9% overnight.

advantages and disadvantages- go!

Firstly, I would never recommend to any trader who looks at their pnl (i.e. marks-to-mkt, mentally or actually) to be a seller of options. This is especially true for retail, where transaction costs are significant. So below applies to being long options:

Advantages:
a) being long options is the only way to hedge liquidity risk, which is inherent in any marked-to-mkt trade (not an investment, which is held to maturity); that's exactly the feature you're describing, TAJammy.
b) being long options offers a smooth payoff, which is a nice feature in a world where we occasionally behave irrationally
c) yet another factor, i.e. vol, where you might find mispricings to take advantage of or can take a view on

Disadvantages:
a) wider bid/offer
b) negative carry
c) introduces another couple of risk factors to manage/pay attention to

BTW, I disagree with NRoth on a few things. Firstly, that old adage about the majority of options expiring worthless has always struck me as a rather silly statement. Overwhelming majority of US flood insurance policies (98.7%, according to FEMA data) never get any claims on them. Does that mean that if you're a homeowner you should never pay for flood insurance? Secondly, I don't understand what the distinction between European and American options has to do with expiring worthless etc.

 

[top trader]

Any good on-line brokers for traded option in U.K?

Thanks

 

[N Rothschild]

Firstly, I would never recommend to any trader who looks at their pnl (i.e. marks-to-mkt, mentally or actually) to be a seller of options. This is especially true for retail, where transaction costs are significant. So below applies to being long options:

Advantages:
a) being long options is the only way to hedge liquidity risk, which is inherent in any marked-to-mkt trade (not an investment, which is held to maturity); that's exactly the feature you're describing, TAJammy.
b) being long options offers a smooth payoff, which is a nice feature in a world where we occasionally behave irrationally
c) yet another factor, i.e. vol, where you might find mispricings to take advantage of or can take a view on

Disadvantages:
a) wider bid/offer
b) negative carry
c) introduces another couple of risk factors to manage/pay attention to

BTW, I disagree with NRoth on a few things. Firstly, that old adage about the majority of options expiring worthless has always struck me as a rather silly statement. Overwhelming majority of US flood insurance policies (98.7%, according to FEMA data) never get any claims on them. Does that mean that if you're a homeowner you should never pay for flood insurance? Secondly, I don't understand what the distinction between European and American options has to do with expiring worthless etc.

well if you plan to execute your option at some point, an american you can execute anytime when in profit..European you have to wait till expiration when it may well be worthless. not sure what your getting at with flood insurance but i agree with your post

 

[Martinghoul]

well if you plan to execute your option at some point, an american you can execute anytime when in profit..European you have to wait till expiration when it may well be worthless. not sure what your getting at with flood insurance but i agree with your post

Yes, true, European options cannot be exercised before expiry. However, that's almost never relevant, as it's pretty much always suboptimal to exercise early. If there's a secondary market, you can always sell your options in the mkt at fair value (less bid/ask, that is).

 

[blancspa]

its like betting that by the end of the week arabiannights will drop in to share his wisdom on this thread

 

[Splitlink]

i'd really like to know this, because they seem too simple, too 'safe'. the fact that you are completely safe with a call option (bar the loss of the premium) if a stock/currency/future etc gaps down 99.9% overnight.

advantages and disadvantages- go!

The sales patter about options is that one can never lose more than the price of the option.

That is true, the problem being that most options lose value or, if the underlyibg price goes up, the option price stands still, at best, because of time wastage.

Think about it. Is it realistic to expect the price go up enough to give a decent return on the purchase price by the expiry date?

Writing them is better but that, also, has its drawbacks, serious ones, if you get it wrong.

In the beginning, covered options were written by institutions so that they could benefit from falls without having to sell long term investments. If they were called, then they would have to sell their shares for the exercise price, but that share was, probably making them a profit at that level, in any case, plus they had the option price.

However, the whizz kids soon found a way to bring option trading to the general public !

You be careful.

 

[TAjammy]

damn, i always thought that no matter the value of the option in terms of premium you could just exercise for a guaranteed profit :O.

 

[Splitlink]

damn, i always thought that no matter the value of the option in terms of premium you could just exercise for a guaranteed profit :O.

Yeah, the brokers love people like you!

 

[TAjammy]

rofl. i still dont understand why you cant simply do that , is it time decay or summit?

 

[Splitlink]

Martinhoul, the way I see it a very large porcentage of out of the money options must expire worthless. The trick is to get something back, no matter how little, even with the in the money options.

What I did, when I was trading them ten years ago, was to buy them with a distant exercise date. That meant that the price went up and down with the share price.

However, (excuse me, I'm very rusty on this, now) probably about three weeks before the exercise date the time wastage starts to kick in. That is when the writers of options get the best price because it will come down to the share value all the way to a few days before exercise. Then, again, the option can be bought by speculators who may expect the price to go up or down in the few days before expiry because of results due, or any thing else.

I got disillusioned by vertical and calendar spread, straddles and all that. I ended up paying the brokers double or more, because each set of options you buy has it's broker's fee. So I I went with straight options.

It's slow, the way I did it and I changed to futures trading.

 

[Splitlink]

Yes, true, European options cannot be exercised before expiry. However, that's almost never relevant, as it's pretty much always suboptimal to exercise early. If there's a secondary market, you can always sell your options in the mkt at fair value (less bid/ask, that is).

Are we talking about the same thing, here? I bought UK share and index options that could be traded any old time.

 

[TAjammy]

all i'd want to do is protect longs on forex with put options and vice versa so that in the very rare event of a big currency gap down the huge leverage on forex wont wipe me out, if the option works fine that is . like can you imagine being long the poundvDmark when soros jumped in, and you had a lie in that morning and you look to see your long is 5% down, 5000 pips-enough to wipe someone out.

The way i see the solution is to 1)use smaller leverage 1:10 1:20 MAX or protect highly leveraged trades with options.

 

[TAjammy]

i've decided through advice by others etc that options are better suited to stocks, if i was ever to trade options i would for sure do them stocks, options though, they seem to forgiving. to me trading them would be like 'im wrong, but not loosing money, so thats ok' whereas losing snaps you back into reality.

i wont be trading options on forex but using smaller leverage,under 1:20. of course with a £300 account it wont get you much

 

[Martinghoul]

rofl. i still dont understand why you cant simply do that , is it time decay or summit?

What is an option? What determines the payoff of the option? What are the two parts that option value consists of?

Martinhoul, the way I see it a very large porcentage of out of the money options must expire worthless. The trick is to get something back, no matter how little, even with the in the money options.

What I did, when I was trading them ten years ago, was to buy them with a distant exercise date. That meant that the price went up and down with the share price.

However, (excuse me, I'm very rusty on this, now) probably about three weeks before the exercise date the time wastage starts to kick in. That is when the writers of options get the best price because it will come down to the share value all the way to a few days before exercise. Then, again, the option can be bought by speculators who may expect the price to go up or down in the few days before expiry because of results due, or any thing else.

I got disillusioned by vertical and calendar spread, straddles and all that. I ended up paying the brokers double or more, because each set of options you buy has it's broker's fee. So I I went with straight options.

It's slow, the way I did it and I changed to futures trading.

To be honest, I really don't understand what this 'majority of options expire worthless' adage means. As to theta (aka time decay), it's, by definition, a fair price to pay for being long the volatility arnd expiry. Bid/offer on multi-leg strategies is a fair point, which is why properly trading options in a retail environment is difficult.

Are we talking about the same thing, here? I bought UK share and index options that could be traded any old time.

I am talking about exercising European options which is what NRoth was describing. Selling/buying the options in the mkt can, in fact, be done any time.