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.
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
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
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.