It’s a question that I’ve gotten many times in the past. If I believe so much in a stock like Facebook, why not buy a call option instead of buying the stock?
The potential gains (and losses) are so much greater. It’s easy to understand why. If I buy for $5000 of Facebook, I’ll basically own about 100-150 shares.
However, by buying call options, I could have an exposure that would be 10 times the number of shares. It’s certainly tempting and I obviously would have done extremely well had I done that instead of buying the stock. So yes, in theory it makes a lot of sense and if you are right on calls like that one, buying options will end up making a lot more sense.
There’s More To Equity Risk In Options
The big problem of course is that when you trade an option your performance depends on much more than the stock’s price. The option will also move depending on changes in interest rates, dividend expectations and volatility
. Those factors are not minor. I personally try to simplify my personal trading and trading volatility clearly does not fit that model. I’ve had the pleasure of working with many options traders and I can tell you one thing. They love trading against retail investors that end up making trading mistakes on options.
Trading Options Is Extremely Expensive
One thing that many retail investors don’t realize is how expensive trading options ends up being. Not only do options need to be rolled once they reach expiry (adding commission costs) but the spread is often much more significant. If you buy a stock worth $40 like Facebook, the bid-ask spread will usually be $0.01. Options that have much smaller prices trade at larger spreads. Over time, that cost adds up and can become significant.
There Are A Few Instances Where I Do Trade Options
In some cases, options really are the best option. Some stocks are very expensive to borrow so having a high delta option (that is in the money and moves very closely to the stock) so using options can work well. In other cases such as covered call strategies, I’ll leave the option selling to pros by buying covered calls ETF’s for example.
Do You Trade Options? If so, under which circumstances?