Warning: There Are Risks Associated With Trading Options

There is a risk associated with trading. One of the first and most notable things that most novice traders or investors would say about options trading, or any other type of trading, is that they all agree they entail a certain amount of risk.

First of all, any trade you make, any investment that has a certain promise of profit, carries some disadvantages associated with it. You get what you pay for. No free rides, no free lunches. When you put up money in an attempt to make more, you instantly throw it into the wind of uncertainty. These same principles apply to making any trade. Investing some money for a higher potential return of more money. The more the money potential is, the higher the risk.

So What Exactly Makes Trading Options A High Risk Venture?

It can be definitely pinpointed to leverage. Leverage, defined when trading, is one of the vital things that can make or break your trade, make money or lose your initial investment. It gives you advantage while at the same time taking away any potential profit, if you happen to pick the wrong option or have the wrong timing. Leverage is one of the attractive things that makes some beginner traders want to start trading. But there are disadvantageous to leverage as well if not properly used. When it come to options trading, there’s higher leverage that’s offered then when buying or selling stocks.

Leverage, as defined in financial terms, is investing a relatively small initial amount of money into an investment vehicle, (in this case an option), that can potentially turn into a much bigger return. Sounds pretty simple and interesting, so what’s the problem? As mentioned earlier, when the leverage is higher, it could easily mean a higher loss of profits, if the trade is wrong or mishandled.

Apart from leverage, The risks associated with options trading can be viewed from two different perspectives: the buyer’s risks, and the seller’s risks.

The Buyer’s Risks When Options Trading
Options trading obviously offers the possibility of you losing your entire investment in a short period of time. It should be noted that the main component when options trading, is the trader being able to control a certain asset, within a stated certain period of time, this at just a fraction of the asset’s price. So if you buy an asset that expires in 3 months, and within those three months, the stock in question remains at a certain price, but lower than what is profitable, you can then easily lose your initial and entire investment rather quickly. The losses will also compound as the expiration date nears.

This is the main reason why novice traders who are interested in options or any other type of trading, are advised and warned to participate only with risk capital. (Capital they can afford to lose)

Also, when trading European style options, which is a version of options trading, restricts traders to exercise the option after it expires, since it doesn’t offer secondary markets. There are other certain option contracts that further create risks as regulatory agencies can put a limit to the possibility of realizing the value of certain options.

The Seller’s Risks When Options Trading
Option trading can also prove risky for the seller. There are certain types of options that offers unlimited potential of loss, depending on the direction of movement of the underlying stock. There’s also occasions when even if there’s no trading market, the sellers are still obligated to sell options.

The risks associated with options trading should be noted and understood beforehand. Any new trader shouldn’t take the risks associated as the hook, line and sinker of the trade. As mentioned earlier, the higher the risk you take, means the higher the profit. So when calculating your leverage, you should also calculate the losses, but also take into account the potential profit you could make from options trading.

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