The buying of options (verses writing them) is the most popular way most new commodity traders start out. Little do they know that over time, their chance for success is 10% at best. The option premium cost over a year is tremendous. Read how most pros use commodity options and how you should too.
I am going to tell you some things about option buying that may save you a lot of money over your lifetime. This applies to both commodity and stock options. First of all, buying commodity options as a routine way to participate in a market's price move for long term trading is a losing proposition over the long haul. In fact, it's probably the leading cause for commodity trading failure by the public.
Most beginning speculative option buyers (and many brokers) wave the flag saying options have limited risk and you can only lose the money you put in. This is true. But at what cost? Paying a hefty option premium to the market for the privilege of holding it for several months is the price you pay. These premiums add up to a tremendous cost over time.
If you are in the market for a year, whether trading options in and out or holding long term option positions, the clock is always ticking and eroding those option premiums. There is a small window when commodity options are priced at good values and can be bought, but it is a tiny fraction of the time when markets get out of line and the historical volatility gets low. The majority of the time, long term option buying is a formula for failure.
In some cases, it may cost you 100% or more of your account value just to pay and maintain that eroding premium privilege for a full year. For example, it is common to pay about $1000 for a three month call option that is near the money. (near its strike price) If the futures market simply chops sideways, goes down or even rallies slightly, the option will expire worthless in three months. Do this three more times to cover a full year and you've spent $4,000 to simply hold ONE out-of-the-money call option for a year.
Multiply this times ten options and you're talking some serious money paid to the "insurance man" so you can feel comfortable for a year. Bear in mind it is not necessary to have an adverse move against your position for the entire year for this to happen. Think about these statistics and realize that most commodity pros consider it a great year if they earn "just" 30% on their accounts - for the year!
How can one pay many times that cost in option premiums and come out ahead? In compaison, if you were holding futures contracts, they would have been near break-even at year's end. That's a tremendous difference to start with. Also remember that when buying options, a good win/loss ratio for a skilled long term trader is only about 10-20% accuracy. This is low but normal and requires huge gains on the winning trades. This win/loss method information is throughly discussed in my free course lessons #2 and #21.
There is a tendency for many option buyers to "load up" and buy way too many options for their account size. I've seen it over and over. Option buyers are very prone to feeling comfortable and becoming "boy plungers." In contrast, serious futures contract traders are very aware of the potential risk and usually take extreme precautions by trading small for their account size. (small is always a good idea for survival - see free course lesson #28)
Remember that I am talking about the dangers of simply BUYING options and holding them. Selling options (writing them) or using them to hedge the risk of futures or using them in spreads to pay for an option buy position, can work well. To use options efficiently means spending the time to find the proper combination to lay off your risk while still participating in a chance for profit.
I am going to tell you some things about option buying that may save you a lot of money over your lifetime. This applies to both commodity and stock options. First of all, buying commodity options as a routine way to participate in a market's price move for long term trading is a losing proposition over the long haul. In fact, it's probably the leading cause for commodity trading failure by the public.
Most beginning speculative option buyers (and many brokers) wave the flag saying options have limited risk and you can only lose the money you put in. This is true. But at what cost? Paying a hefty option premium to the market for the privilege of holding it for several months is the price you pay. These premiums add up to a tremendous cost over time.
If you are in the market for a year, whether trading options in and out or holding long term option positions, the clock is always ticking and eroding those option premiums. There is a small window when commodity options are priced at good values and can be bought, but it is a tiny fraction of the time when markets get out of line and the historical volatility gets low. The majority of the time, long term option buying is a formula for failure.
In some cases, it may cost you 100% or more of your account value just to pay and maintain that eroding premium privilege for a full year. For example, it is common to pay about $1000 for a three month call option that is near the money. (near its strike price) If the futures market simply chops sideways, goes down or even rallies slightly, the option will expire worthless in three months. Do this three more times to cover a full year and you've spent $4,000 to simply hold ONE out-of-the-money call option for a year.
Multiply this times ten options and you're talking some serious money paid to the "insurance man" so you can feel comfortable for a year. Bear in mind it is not necessary to have an adverse move against your position for the entire year for this to happen. Think about these statistics and realize that most commodity pros consider it a great year if they earn "just" 30% on their accounts - for the year!
How can one pay many times that cost in option premiums and come out ahead? In compaison, if you were holding futures contracts, they would have been near break-even at year's end. That's a tremendous difference to start with. Also remember that when buying options, a good win/loss ratio for a skilled long term trader is only about 10-20% accuracy. This is low but normal and requires huge gains on the winning trades. This win/loss method information is throughly discussed in my free course lessons #2 and #21.
There is a tendency for many option buyers to "load up" and buy way too many options for their account size. I've seen it over and over. Option buyers are very prone to feeling comfortable and becoming "boy plungers." In contrast, serious futures contract traders are very aware of the potential risk and usually take extreme precautions by trading small for their account size. (small is always a good idea for survival - see free course lesson #28)
Remember that I am talking about the dangers of simply BUYING options and holding them. Selling options (writing them) or using them to hedge the risk of futures or using them in spreads to pay for an option buy position, can work well. To use options efficiently means spending the time to find the proper combination to lay off your risk while still participating in a chance for profit.
Part Two of Four Parts - Next!
There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.
Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete 44+ lesson, "Thomas Commodity Trading Course" - they're all free. http://www.thomascapitalmanagement.com/commodity/welcome.htm Main site: http://www.ThomasCapitalManagement.com
Article Source: http://EzineArticles.com/?expert=Thomas_Cathey
Article Source: http://EzineArticles.com/?expert=Thomas_Cathey
No comments:
Post a Comment