Matt specializes in writing about bank stocks, REITs, and personal finance, but he loves any investment at the right price. Follow him on Twitter to keep up with his latest work! Follow TMFMathGuy Options can be a useful investing tool when used correctly, but they can become your worst nightmare if you don't fully understand what you're getting into.
With this in mind, we asked three of our contributing writers to talk about what investors need to know before entering the complex and often dangerous world of options trading. Here is what they who traded options to say: Dan Caplinger: Trading options can seem like a great way to get rich quick in the stock market, as options prices can move much more dramatically than stock prices in response to a particular news item.
The big problem, though, is that the institutions that make markets in options stack the odds in their favor by maintaining large bid-ask spreads that can siphon away your money if you're not careful. With a typical stock, the spread between what a market maker is willing to pay you if you want to sell your shares and what you'd have to pay to buy shares is generally just a penny or two, especially with popular stocks. What that means is that, even if you make a smart trade, you'll lose a substantial portion of your profit to transaction-related costs -- and it will make the odds of your finding a winning trade correspondingly lower.
Trading options can be a smart way to take advantage of profitable situations, but you have to be careful to watch bid-ask spreads, and to avoid circumstances in which the market maker will take away most of your profit potential.
Matt Frankel: Just like everything else in investing, there are right and wrong ways to trade options. On the other hand, one potentially good use for options contracts is covered call writing.
But if the shares close above the strike price, I'd be forced to sell them for below market value. Jordan Wathen: Options trading results in very different tax consequences than simply buying and selling stock -- though, if you don't intend to ever exercise your options, you shouldn't have much who traded options a problem.
Options held for less than one year result in gains taxed at ordinary income rates.
Options held for more than one year are taxed as long-term capital gains. This is exactly how gains on stocks are taxed. However, exercising your options changes the tax impact entirely. You just turned a long-term gain on the option into a short-term gain on the stock, and your returns suffer for it.
The bottom line: Options create unique tax considerations that most investors will never encounter in stocks. Tread carefully.
- However, this is not a complete risk analysis, and in reality, short options trades have no more risk than individual stock trades and actually have less risk than buy and hold stock trades.
- Getting Acquainted With Options Trading
- Whether you prefer to play the stock market or invest in an Exchange Traded Fund ETF or two, you probably know the basics of a variety of securities.
- Training in binary options from traders
- Trading options is very different from trading stocks because options have distinct characteristics from stocks.
- Essential Options Trading Guide
- Options trading is a lot different from trading stocks or mutual funds, but it can come with some real advantages for investors.
Motley Fool Returns.