Saturday, March 04, 2006

Stock vs Option 1---Riskier or Not

Trading stock or trading option is all depends on your investment strategy. Most of people would suggest you to stay away from option trading because it is too "risky".

Is option trading riskier than stock trading ?

An option has its strike price and its expiration date. You have to predict the stock price direction correctly before the expiration date; otherwise, you will loose money.

If you bet the stock in a wrong direction, you can easily loose most, might be all, of your investment. If you bought stock, you can hold it for a longer time to wait its recovery (if there is one), or you can sell it at lower price, but still have most of your investment money back. Therefore, trading option would loose more, percentage wise, than trading stock when you chose the wrong direction.

Sometime the price of your stock might be at or even better than your expectation, but you can still loose your money simply because your option is expired. For trading stock, it is not a concern.

But it is not true that the option is riskier than stock all the time. Let me give you an example: If there is a stock ABC which current price is 20, you think it should go up to 25 in 3 months. You could buy option which expires in 3 month and has strike price 25 at cost of 2.5; or you could buy the stock at 20. Suppose you were wrong, the stock dropped to 15 at 3 months later. Assume that you did not sell your option or stock, then you would loose 2.5 at your option; but you would loose 5 at your stock! In such case, trading option is seems better than trading stock.

We cannot simply say neither option nor stock is riskier than another. It is all depends. To better handling the investment risk, it is not really the ways to trade; it is rather the money manager skill.

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