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doctorpot1
shared12/06/2022 01:31
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Myth: Options are all highly leveraged, Options are all super risky.

TLDR: People who say options are all highly leveraged and super risky, are like people who say that investing is super risky. They don't understand the tool fully, and have a selection bias based on stories of people losing it all in the market. Investing can be super risky (by picking leveraged ETF like $ProShares UltraPro QQQ ETF(TQQQ.US)$ or $ProShares UltraPro Short QQQ ETF(SQQQ.US)$), but it can be super safe too (by picking T-Bill like $Treasury Yield 5 Years(.FVX.US)$). Just like how investing is on a spectrum, options are on a spectrum too. Options can be used in a super risky, highly leveraged way, but it can be used in a safe, zero leveraged way too. It can be setup to give us 4000x leverage, but it can have no leverage at all too. It is just a tool, a super flexible tools.
Story time
Many people who don't fully understand options, love to tell others that options are ALL highly leveraged, and ALL are super risky. This is 100% false. Options is just a tool, a tool that allows us to create highly leveraged position as well as position that have no leverage. It allows us to create high risk high reward position, but it also allows us to create safer position compared to trading shares outright. It lies on a spectrum, just like investing.
In investing we can also create highly leveraged position using leveraged ETF, and we can also pick high risk high reward stock. However, we can also create a safe position by only doing T-Bills. It is also on a spectrum, but there are still many people who don't understand investing keeps on saying that ALL investment are super risky. If we listened to these people and avoid learning about investing or options, then we lose out on the ability to use powerful tools in the game of financial freedom. While the unlearn used a spoon to dig for gold, the learnt is using a bulldozer.
If you are new to options, or do not know what options is about is, you can click on the Option 101 post below to learn more about it. In the post, I also showed how a CALL option on $Alibaba(BABA.US)$ can be used in a way to gain 9x leverage for a high risk high reward setup; As well as how the exact same $Alibaba(BABA.US)$ CALL option can be used in a way with no leverage, safer method with a build in stop loss.
Debunking Myth 1: Options are all highly leveraged
It is important to first understand what does it mean by leverage. To leverage is to get into a much larger position than you can afford, usually on borrowed money. For example you only have $50, but you got into a position as though you got $1000 right now.
Buying a house is a real life example of us using lots of leverage. By just having $150k of downpayment, we can borrow money to buy a house that cost $1million. That is a 6.67x leverage, but people seems to be ok with it. I guess they aren't scared that they lose their job and can't pay the loan, or when their property price crashed 50% like in 2008 financial crisis.
Therefore, if we have $1000 and we buy stocks that cost $1000, then we didn't use any leverage. If we have $1000 and traded option that if fully exercised would cost us a total $1000, then we didn't use any leverage. What we can see here is that leverage is not the problem of the option, but it's about how the person used the option. Using options, it is easy to gain 10x leverage, 30x leverage, and even go higher then 4000x leverage; But is is also very easy to not use any leverage. Options give us the ability to use leverage, but we can choose not to use leverage.
For example we could buy Cash Secured CALL option. What it means is to have enough cash to both buy the option and exercise the option.
Myth: Options are all highly leveraged, Options are all super risky.
In this example above, this is a $UP Fintech(TIGR.US)$ CALL options that I bought for average cost of $368 per contract. Since its strike price is $2.50, that means that I would need to have $250 in cash per contract to exercise it. So when I'm buying the CALL option, I just need to make sure that I have $250 in moo moo, after paying for the CALL option. See zero leverage! So simple!
Debunking Myth 2: Options are all super risky
Will it surprise you if I told you that because I bought CALL option on Up Fintech, it actually makes it much safer as compared to buying the shares?
It is important to note that options is nothing but a contract to buy and sell 100 shares. Based on how you setup the structure, it can be safer than buying shares, it can be riskier than buying shares. Now let's take a look at the CALL option. Instead of buying the CALL options, we could have just bought 100 shares of $UP Fintech(TIGR.US)$ which at the time would cost me $580. We know that Chinese stock is very risky. What if a bomb was drop and all Chinese stock goes to $0? If we bought the shares directly, we would had lost all $580. But if we "buy" the shares via the long dated, deep in the money CALL option, we only risked $368 up front. If it goes to $0, all we lost is $368.
Another way options can be way safer is when we use options to "short" a stock. Using options to short a stock is so much safer than someone shorting the stock directly. Shorting a stock is a very risky move as we have a limited profit potential but an unlimited loss potential. However, if we were to buy PUT options on the stock, we could "short" the stock while ensuring that there we won't have an unlimited losses.
Myth: Options are all highly leveraged, Options are all super risky.
In this example above, this is a $Credit Suisse(CS.US)$ PUT options that I bought for a cost of $30 per contract. Back then Credit Suisse was about $4.8, and there are rumors that the company may go bankrupt. So if we were to short the stock directly, the maximum we can earn is $4.8 if CS goes bust, but if CS rallied and goes to $14.8, we lose $10 per share. if it goes to $548, we lose $500 per share. But by buying this PUT options instead, if CS goes bankrupt, we earn $4.2 per shares ($4.5 - $0.3), if CS goes to $14.8, we lose $30 in total for 100 shares. If CS goes to $548, we lose $30. If CS goes to $9999, we lose $30.
We get similar payout as though we short the shares, but we limit the losses. Thus, it is much safer. So options are all risky? really?
Debunking Myth 1 and 2: Options are all highly leveraged and super risky
Another example of option position that uses no leverage and technically is safer will be to sell Cash Secured PUT option to buy shares. What it means is to have enough cash to buy the shares when the buyer exercise the option.
Myth: Options are all highly leveraged, Options are all super risky.
For example example, this is a $NIO Inc(NIO.US)$ PUT options that I sold for $112 per contract. I wanted to DCA my NIO at $10 a share so I sold it. Since its strike price is $10, that means that I would need to have $1,000 in cash per contract just in case the buyer choose to exercise it. Since I collected $112 for selling it, I would just need to top up another $888 per contract. See zero leverage! Plus, I collected extra cash for trying to buy the share which is what I would have done anyway. This technically reduced my risk too as I'm putting up lesser money.
I know there is a famous YouTuber who advocates for buying $SPDR S&P 500 ETF(SPY.US)$ when it crash, but he hates option to the core. He could have just sold Cash Secured PUT option at his desired entry price and earned extra premium on it. No leverage, safe (because he will buy anyway when S&P500 crash) and he can gain extra income. What a waste.
Conclusion
Yes, options can be used in a way that is super risky and highly leverage, but it can also be used in an non leverage and safer way. That is the beauty of options, and that is the power of knowledge. Now that I understand options fully, I can use it to my advantage. In a roaring bull market, maybe it is smarter to use it to gain some tiny leverage. In a bear market, maybe it is smarter to use it to get discount to buy shares. Invest smart! Invest safe GrinGrin
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  • Divinemama : Excellent Thumbs UpThumbs UpThumbs Up

  • doctorpot1OP Divinemama: thank you for your support GrinGrin

  • 102872488 : thx. I m new to options. really helpful article.

  • doctorpot1OP 102872488: no problem Joyful you can check out this post to learn more too Explained Simply: Options 101. moo moo also have options courses and chat group for and Q&A Joyful

  • ZnWC : Thanks for giving me a wider perspectives about options.
    I also sold covered secure put to buy discounted stock.

  • OlaTrade : Great written article doctorpot1. Does sell put option contract auto exercised upon expiry?

  • doctorpot1OP ZnWC: No problem Joyful yea CSP on stocks you want is like a win win move, get discounted stocks or get free money hahaha CheerleadCheerlead

  • doctorpot1OP OlaTrade: Thank you Joyful selling put option doesn’t auto exercise upon expiry. The buyer have the power to choose if they want to exercise it or not, so as a seller we just have to wait and see. Usually if the stock price fall below the strike price, the buyer will exercise it. Otherwise not.
    So for the NIO example, if NIO falls below $10 then the option will be exercised. If it is above 10 then nothing happen. I keep the 112 and i can sell put again.

  • 102970152 : Your may interested ito find out more on Singapore market DLC 5x to 7x leverage, long / short limited loss

  • doctorpot1OP 102970152: Yea I do know about them too Joyful the leverage is daily compounding so you can go up really fast and down really fast haha Laugh using options on those leverage product gives you even more leverage... but the issues with DLC is the daily compounding, we could be right about the direction but still lose money if the stock price is volatile Sob options doesn't have this issue cause by the daily reset

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