A lot of traders start to buy or sell without knowing the risks and profitability of options trading. Well, the good news for you is that after reading this article, you will be able to make a well informed choice about Options trading.
Before seeing if option trading is profitable or not, let us first understand what option trading is:
What is Options trading
Options trading is the trading of instruments that give you the right to buy or sell a specific security on a specific date at a specific price. An option is a contract that’s linked to an underlying asset, e.g., a stock or another security. Options contracts are good for a set time period, which could be as short as a day or as long as a couple of years.
How much can you expect to earn from options trading?
This is one of the most common questions asked by people who are starting out as a trader and are just not sure if they should invest their time and money before knowing if they can make decent money from options trading. If you are one of those people, don’t worry, we have got you covered.
Option traders can make a monthly profit of 1.9%-6.67% of their account value depending on the strategy they are using.
A lot of people have unrealistic expectations like earning $500 per week on a $5000 Account, which is not really not possible no matter what strategy you adopt. If that was the case, everybody would leave their job to start trading.
Here are some realistic profitability goals if you have a $5000 Account –
Account Value – 5000 USD
Monthly Returns – 95 – 333 USD
Yearly Returns – 1100 – 4000 USD
How to profit from options trading
Options traders can profit by being an option buyer or an option writer. Options allow for potential profit during both volatile times, and when the market is quiet or less volatile. This is possible because the prices of assets like stocks, currencies, and commodities are always moving, and no matter what the market conditions are there is an options strategy that can take advantage of it.
Options or Option trading can be extremely beneficial if one moves cautiously and evaluates the risks involved.
Risks involved in Options trading
1. No Returns
For the buyer of an option, the most obvious danger is that the underlying asset doesn’t move in the desired direction, forcing them to let the contract expire. So, they paid the premium for nothing. Have this happen often enough, and it can add up.
2. Proper Timing
Options trading doesn’t simply necessitate an accurate prediction of whether a stock will go up or down, but also an accurate prediction of when it will make its move. You may be correct in thinking that a company is going up, but if your option expires before it surges, you won’t be compensated for your premium with a profit.
Options are short-term investments that run for a few months. The shorter time gives less time for price recovery. So the chances of losing money are also as high as earning profits out of it. Being a derivative of stocks, indexes etc., a small movement in the underlying stock or index price can cause sharp movement in the options pricing.
Advantages of Options Trading –
1. Cost Effective
Options have great leveraging power. An investor can obtain an option position similar to a stock position, but at huge cost savings. The investor has to pick the right call to purchase to mimic the stock position properly. However, this strategy, known as stock replacement, is not only viable but also practical and cost-efficient.
2. Less Risky Than Equities
There are situations in which buying options are riskier than owning equities, but there are also times when options can be used to reduce risk. This is because they require less financial commitment than equities.
3. Enables Investors to Fix Stock Price
Option contracts let investors freeze the stock price at a certain dollar amount (the strike price) for a specific period of time. Depending on the type of option used, it guarantees that investors will be able to buy or sell the stock at the strike price any time before the option contract expires.
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