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What are options and should you trade them?

  • April 02, 2021
  • Noah Weidner
What are options and should you trade them?

There’s a new stock market in America. Not in the sense that we’re releasing sequels like “New York Stock Exchange 2: Return of Stock Man.” But, in the sense that markets have been flipped on their head with record participation by retail investors. It’s clear that they are present and aware of the influence they are capable of having. It’s also clear that the media is (finally) aware of that influence as well.

Over the last few weeks, the mainstream media have covered online reddit and discord communities for investing. The most prominent one covered is r/WallStreetBets, which added millions of new subscribers overnight, in light of the GameStop short squeeze and subsequent media coverage. Some people might not have had the luxury to visit r/WallStreetBets in a time before GameStop. However, I can say as a long-time browser that the most rewarding content on the subreddit were always the posts in the ‘gain’ and ‘loss’ flairs. You could peer into complete strangers’ portfolios and see the outcome alongside some pretty comical commentary. Some of the most famous r/WallStreetBets moments include the “GUH” trade and infinite money glitch.

You don’t need to spend a long time in these flairs to ascertain that most of these posts are from: a) relatively new investors; b) people who don’t care about consequences; and c) are trading options. Seeing these astronomical gains and losses is likely what attracts people to options. They tend to be either eye-widening gains or eye-watering losses. But, what are options and should you even bother trading them?

What are options?

If you’ve ever tried your hand at sports betting or politics betting, options are like that – but, a little more complicated. It’s basically gambling on the price of a financial product. In this case, we’ll just talk about options on stocks.

The anatomy of a basic options trade is simple: you are betting on a stock being above or below a certain price by a certain day. At its core, it’s best to think of options as a market on top of markets. Options exist for speculation around the price of financial products like stocks or ETFs. If something is likely to happen, the price you pay for that option or “bet” will be higher. If something is less likely, the price you pay for that option will be significantly lower. However, all options come with an expiry date baked in. If that date is closer, then the odds of something affecting that market will be lower. If that date is further out, then you will probably pay a premium. Ultimately, if the stars don’t align and the price you bet on is not met by the expiry date, then you stand to lose all the money that you invested in that particular option.

Once you understand options, you can use strategies to bet that stocks are going up, down, staying the same, being volatile, and so on. Like with every bet, there’s always someone else willing to bet you’re wrong. 

There are a few reasons why someone might prefer options to buying stock. Let’s say the price for buying a stock is relatively high, but you want to still gamble on the price going a certain direction. You can do that with the options market. Maybe you understand the movement in a particular stock, fund, or market really well and you have a strong sense that the underlying product’s price might stay the same. You can do that with the options market. Ultimately, 

we’ll leave the finer details on options to someone else, mostly because we think that investors need to familiarize themselves with the risk. It’s also because options are relatively complicated and nobody in their twenties is going to read a book on them – they’re going to go to YouTube anyways. 🙄

Should you trade options?

Ultimately, a more important question for new investors than “what are options?” is: “should I trade them?” For most investors, the answer is no. Not because it isn’t fun or interesting, but it’s because of the cost and risk.

Options contracts are priced based on the price of a stock. In short, this means that options for prominent stocks like Apple and Tesla are going to be a lot of money. In some cases, the contracts for these contracts can be thousands of dollars. Remember: that’s thousands of dollars that you can lose if you’re wrong. Betting on a stock going up or down in your head or on Twitter is free and won’t cost you thousands, so maybe consider doing that until you have money to burn. And, even then, do you want to (potentially) burn it?

In the case that you actually happen to be: a) wealthy enough to throw money around or b) highly aggressive with your risk profile, then maybe options trading would be worth your while after you read up on the subject. Watch a few YouTube videos, use options calculators to see example scenarios, and try strategies on paper before even thinking about “YOLOing your money” on any options. The decision to trade options is not one you should take lightly, especially if you are new to investing. We’d highly recommend not checking into that casino until you’re confident with your investments.

However you choose to invest, do it with confidence. This is where Front can help. Use our free app for smart stock and portfolio analysis to help you make better investment decisions. These days, the stock market is fast-paced and volatile, so remember that you’re in it for the long-term return. Even if you do experiment with some of the riskier investments, why not protect yourself with some solid, stable investments, too?

Your path towards smarter investing begins with Front.

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