Options Trading Risks
Sensible stock market operators always advise understanding the risks involved with trading and investing, and options contracts are no exception. For this reason, we decided to take a closer look at one of the riskier elements to trading on the stock market.
Options contracts allow market participants to lock in prices or profit from price fluctuations, and with the correct knowledge, there is no reason you can't achieve financial gains from this complex trading tool. However, the potential for loss is ever present, and it can occur in the following ways.
- Leverage - It's the most obvious and one of the biggest considerations to those interested in options trading. Small market movements can make you large amounts of money, and they can also deprive you from profit.
- Writing Options - Although when taking a put or call option, your potential for loss is limited to your initial margin, if you choose to write an option on an asset you already own, your potential for loss is theoretically unlimited.
- Expiry Date - Unlike other investment vehicles, options have a relatively short shelf life. If a share price goes down, you can sell it at any time or hold it until value returns. Options may force you to act in unfavourable conditions.
- Market Risks - Being a derivative, options are still susceptible to all the market risks of typical investments. Trading disputes, global conditions and unexpected volatility can all affect options trading.
- Liquidity - In some cases, liquidity may become a problem with options, especially of you are trying to close out a position close to expiry. It's important to understand your goals and have a solid strategy to minimise the chance of liquidity issues.
There is a wealth of information available on options trading through the ASX and various other trustworthy sources. You can trade options online just like shares, and if you're unsure or are trading options for the first time, speak to a professional or obtain advice from a good full-service options broker.