The trading community holds a misconception that options trading is all about risks. Of course, options might be risky, but they don’t need to be. Options tend to be more or less risky, based on your strategies and risk tolerance. Of course, you can use options for speculation, but you can also use the same for protection, leverage, and hedging. So, when you plan to open an account to trade in options, steer clear of the following myths.
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Myth 1: Trading options tends to be a zero-sum game
The fact is that options can be utilized as an insurance policy. You can use them as a risk management tool, and not just a trading vehicle. Let’s explain this matter further.
If you purchase the call option and earn profits by selling at higher prices, you have no reason to think that the seller takes a loss that corresponds to your gain. The sellers might have hedged the play and earned a profit that’s even bigger than what you did.
There is nothing that resembles the zero-sum game in the hedged options transaction. Many people consider it to be a black-and-white game: when one gains, the other loses. Now that is an oversimplification.
Myth 2: Not more than 90 percent probability strategies earn well
Many traders believe that 90 percent probability strategies are the Holy Grail of options trading. 90 percent winning ratio ideas in options typically refer to ‘out of the money kind of credit spreads that contain a 90 percent probability of complete expiry. To get a 90 percent probability, you need to sell the credit spreads with shorter deltas of around ten.
The problem is a 90 percent probability trade means the risk/reward is horrible – typically around 1:9, which means you risk $9 in order to make $1. Moreover, with a 90 percent probability trades, the maximum loss remains limited to eight to ten percent, though it can be 100%.
It means you can continue to lose money even after a 90 percent winning ratio. Also, if you win 10 percent five times consistently before losing 50 percent, you won’t be back to even. You’re still down 25 percent.
Winning ratios aren’t enough to show the big picture. In fact, they are basically meaningless. The thing that should matter is the average return per trade and not the winning ratios.
Myth 3: Money is made only by options sellers
Both sellers and buyers of options can benefit from options trading. When only the sellers make money, there will be no buyers. There will be no market without buyers. Though options selling has its own edge in several cases, you also get exposed to negative gamma.
Remember that premium buying is the road less traveled, but it remains profitable for the disciplined, well-prepared trader. That does not make it better or worse than opting for premium selling. Simply stated, there are multiple ways to reach one goal – making profits.
Make sure to stop believing in the myths and misconceptions mentioned above when trading in options.
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