> as a novice, you have no business mucking around with such dangerous things, but as an initiate, you have no need of the article.

That reminds me of an ex-girlfriend's "if you don't already know what you did wrong, I'm sure not going to tell you!"

More seriously, somewhere along the path from novice to initiate, you have a need for some material, though - be it this article or another.

Also, I'm not implying you do, but I find it funny that many people think "stocks are a fine investment, but options are dangerous".

The only real difference in risk is leverage, which is always high in options, and usually low in stocks. But you CAN get high leverage for stock trading, and you CAN restrict yourself to a small part of your capital thus "deleveraging" the effect of options on your portfolio. You need to have some experience, but definitely of the calibre of a Fugu chef, to practice these.

I think the close proper analogy is the stocks are a sharp household knife, and options are a butcher's knife.

Ex for a reason, I see :)

There's a bit more to it than just leverage. Writing naked options carries huge potential downside, unlimited in the case of naked calls.

With a stock you're long, or short. Prices go up and down. Four outcomes to consider. Options are a bit more involved: covered or uncovered? call or put? long or short? Then you've got the option price and the underlying price to think about. Until you're comfortable, it's more than most can manage in their heads.

Since we're doing 'sharp tool' analogies, I'd be more inclined to go with hand saw and chainsaw. The level of potential harm you can do to yourself in an instant with a chainsaw is far greater than that you can achieve with a hand saw - and it's a much bigger difference than that between the efficiency of using a chainsaw and a hand saw. Yes, it's powerful, but it's disproportionately hazardous in untrained or careless hands.

I mostly agree with what you wrote, however:

> Writing naked options carries huge potential downside, unlimited in the case of naked calls.

The same unlimited potential downside exists when shorting a stock.

But you have to be a pro to get away from the risk & margin checking. (Unfortunately, it's actually possible to do that, and most pros do). And until you've escaped from it, the downside is limited to not much more than what you have put down as margin.

Good point. As you said above, it's the leverage.

Buying options is a great way to derisk your portfolio, as your risks are much smaller than trading real stocks for a given position for most thing.

Now SELLING Them, that's a different story. Selling positions when you do not have the stock as security to hand over is pretty risky.

I'm guessing I'm the "readership for such things", as I don't know much about options, but also don't plan on doing much with options in the near future, either.

I'm curious to know, though, what you think I should know before looking into options?

At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose.

There aren't always market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later. Worse, you can short a lot of options and not be able to cover your position, so you really do need to be comfortable with the worst-case scenario.

You should also look into the details of how your broker deals with options if you hold them until expiration - otherwise you might end up with a lot of stock you don't want (or vice versa).

edit: corrected based on chollida1's response

> At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose.

This. Actually, it's not just the minimum - it is the best way, and possibly only way, in many cases.

Many traders/investors went bankrupt by assuming some statistical model of how things behave, and using this data, assumed that e.g. with 99.999% confidence, one trade's profit will be able to cover another trade's loss if things go bad. However, when things go bad, they tend to do so in ways that do not match historical patterns, and thus these models are invalid.

Also, if you are short call, long put, long underlying (in the right proportion) then theoretically you cannot lose. However, the options and underlying are likely to trade in different markets (with different rules, different margin requirements, and lacking a netting agreement), and as a result, extreme market movements may make your "perfectly hedged position" a huge loss because e.g. your underlying gets liquidated due to a margin call at the bottom of a flash crash, but your synthetic future remains; and now you're exposed.

> There are no market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later.

Where did you hear this? While it's true that not every market has market makers, there are many market makers for CBOE and MEOP options that are blessed by the exchanges.

On top of that there are many more funds that make their living solely on being option market makers. We do pretty well in the Canadian markets.

Corrected, thanks for pointing that out. I heard an anecdote of someone buying a lot of options and not being able to close the position later - I guess it happened in an illiquid market.

Yep, it's not uncommon to look at the book for an option and see huge sizes on one side and no one at all on the other side.

Could you explain this a little better? I'm sure you're not contradicting yourself, but that's how I'm understanding it.

What risk is there of not finding the other side when you are playing the options game? In your first post you seem to imply that this isn't really a risk.

Ah, I see what you mean. Yes in this case I'm contradicting my self a bit.

The thing about options, as compared to stocks, is that they can be literally worthless. A stock that is bankrupt can still have a buy side bid of a few pennies as the buyer can hope for some cash from the bankruptcy proceedings.

Consider a Call option on facebook for Nov 16th with a strike to buy at $40.

This means you can buy facebook for $40 up until Nov 16th. Currently FB US Equity is trading at $19.50, so with 2 days left and it's historic volatility there is almost no way it's going to get to $40 and make your option worth anything.

In this case the Sell side of the book would have many offers as everyone would love to sell this call for any amount of money as it's worthless.

On the buy side you'd expect no bids as there is almost no way this could make you money.

Now when I mentioned market makers I was referring to trading options that still have some value. I assumed that the OP was talking about not being able to sell options when they had some value, in this case there is always someone willing to act as a market maker in this case.

Thanks, that makes a lot of sense.

I thought there was the implication that somehow you might not be able to exercise your option due to lack of market maker.

Thanks! Using options conservatively - buying small amounts, or only writing covered options - can be a great way to mitigate the risk involved in trading just stocks.

You're right that writing naked options, or using more advanced strategies, is a great way to lose a lot of money, but commercial brokers usually stop people from doing that unless they have a good reason for it (or at least know what they're getting into).

Absolutely. Options are a tool, like any other. If you hold it wrong, though, the sharp edge can give you a really bad cut.