No doubt you’ve heard of people making several times their money on a position that they took buying stock options. Certainly people are quick to relate huge victories such as this, but we rarely hear of the times when people lose 100% of the money they put into options position. The fact is that 80 or 90% of the time long option positions result in a total loss for the buyer. So what, if any, place do they have in the portfolio of a person who does not consider them selves a compulsive gambler?
The answer is that there might be a very small place in your portfolio for buying stock options, say 5% of your total portfolio value, in the hope that periodic large gains with small amounts of money will be useful in increasing your overall portfolio value. There is also the chance to use stock options to hedge yourself, by writing-or selling-covered calls or puts against stock that you already own.
There are many places on the Internet to get both buying and selling options explained to you, but suffice it to say that where you desire leverage, you should resist the impulse to over-invest in options in favor of taking a safer, long-term view, by putting money in unleveraged investments. Also, especially if you have a rather large existing portfolio already, you should look seriously at selling covered calls and puts as insurance against potential downturns in individual stocks or ETFs that you own. Selling covered options in this way will reduce your cost basis for each underlying security that you have, though you will have to forfeit potential big gains should the stock keep going up (in the case of calls).
Options aren’t mere simulated business games, despite all the hype that you’ll see on the Internet touting trading platforms that make trading them seem like nothing more than a completely immersive video game. If you’re tempted to invest in options with actual money you owe it to yourself to learn the game inside and out beforehand, by paper trading.
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