Our verdict: look before you leap
Options are legitimate financial products and trading them can work, but to be successful you’ll need significant time, skill, expertise and mathematical abilities. With options, no wealth is “created”, merely transferred. You pit your wits against an efficient financial market; the prices you pay have generally already factored in the experts’ opinions about what might happen in the future.
Trading optiosn is not easy, it’s not low-risk, and big profits are anything but guaranteed. Stockbrokers say the only reliable way to make money from options is by writing (that is, selling) call options against large share portfolios you already own. But of course such trades also have risks – a rise in share prices could force you to sell your shares for less than they’re worth.
If you do want to pursue options trading, instead of paying out thousands of dollars for training and software, start with free online content, books and other relatively inexpensive materials to educate yourself.
A $40 book can explain both the basic and more complex strategies and give you a feel for whether options are for you. For ideas about where to start, see below.
Other industry opinions
Options are used by professional and institutional investors to hedge (insure against) their risk or exposure to changes in share prices. Sometimes they sell options to pocket the premiums and hope the market doesn’t move against them; in other cases they buy options to hedge risks or take speculative positions that could earn them money.
Some financial planners, such as Marie Bermingham, occasionally use options as a way to protect individual investors' share portfolios. "We use options as a protection and risk management strategy, but not as a way to make money," she says. "Options have proved to be an absolute winner over the last two years. At end of 2007 and early 2008 we locked in some good share prices for clients, before the share market downturn, preserving their capital." However, Bermingham doesn't think average investors should trade options looking for big profits. "Options are not for the fainthearted and only sophisticated clients and investors should use them. It's possible to make money, but it is also possible to lose a lot of money. I wouldn't recommend giving up the day job. And you don't need to buy expensive software to trade options, but you do need quite a bit of knowledge."
James Ramsay, an equities dealer with stockbroker Bell Potter Securities, also warns consumers about the dangers of options trading. "Without strict risk management strategies in place, options can go against you and wipe you out. Don't trade options if you're not a sophisticated investor or don't have a knowledgeable adviser. Options have their time and place but you just need to know when to use them."
“Trading stocks is hard enough, but options are a whole lot harder,” says Travis Morien, a financial planner. “Options were designed as a tool to allow people to manage risk. It’s ironic therefore that in the hands of speculators they can be the most risky investment of them all. Options are much harder to analyse than stocks. In general, I think about amateurs trading options pretty much what I think about amateurs doing brain surgery, with high explosives. It usually ends badly.”
Sean Nofal of amscotOnline, a discount stockbroker offering share trading but not options, emphasises the view that any market strategies are best kept straightforward. He says the brokerage favours very straightforward strategies in markets which are as transparent as they can possibly be. "The appeal of derivatives is based on two factors - leverage and time value, both of which involve significantly increased risk. Time value involves using a rocket-science style formula which is designed to encourage buyers of risk to pay more than it's really worth, sometimes by a very wide margin. It might all sound very scientific and exciting, but those embarking on complex options strategies involving multiple straddles and strangles can expose themselves to unforseen and dramatic risks. Your analysis needs to be totally accurate. If not, you wouldn't be the first, including many professionals, to totally blow yourself up." In investing, as in most things, Nofal advocates KISS - Keep It Simple Stupid. In this regard direct investment in ASX Equities fits the bill.”
The Australian Securities Exchange provides free options fact sheets and audio-visual presentations on its website. Its book, Trading ASX CFDs, Options and Warrants the ASX Way, is published by Wrightbooks and retails for $39.95.
Become familiar with the derivative (options) tables and figures quoted in daily newspapers, such as the Australian Financial Review and on the ASX website.
Two-hour introductory Options Fundamentals training courses are available from the Securities and Derivatives Association for $764.50 for non-members. While mainly attended by new entrants to the stockbroking and financial planning industries, the SDIA says these courses assume no knowledge and are suitable for investors considering options in their trading strategies.
You can also check out what other readers say about options trading and these seminars, and have your say.