Trading shares or exchange traded options? Which is better?

[dead trader]

Hey guys,

I was having a long hard think today (well, tonight to be more precise) about what would be more profitable...

To trade shares outright and pay 0.07% brokerage, or trading options on ASX listed companies and paying 0.28% brokerage?

I was trying to put some numbers into a spreadsheet but didn't get very far.

Like I put "buy 200 XYZ at $50, sell 200 XYZ at $55" = $1000 gross profit

Then below that I put in 0.5 (50 cents profit per option) x 100 (contract size) x 100 contracts plus brokerage... = $5,000 gross profit

I wrote this to simulate an option going from $1 to $1.50.

For those two examples above I used a hypothetical bank of about $10,000.

It seems to me there are more profits to be made trading options, but also higher fees (which I don't like. Also I'm unsure how tax works at the end of the year for option traders....)

If this is correct, and option trading is more profitable than mere outright share trading, why don't more people trade options? Is it just me or do most people prefer to trade shares?

Am I missing something??

 

[cynic]

Extrinsic value, (a.k.a. time premium) and implied volatility are factors that merit serious consideration when comparing option trading scenarios with the direct trading of an underlying security.

Should either implied volatility drop sharply, or the underlying take a sufficiently long time to achieve one's intended profit target, the option may dramatically underperform consequent to the resultant reduction in extrinsic value.

 

[hhse]

You are missing a number of very important things. As cynic may have already mentioned:

* Time decay - this is where you will lose most of your money. With options you only have a limited amount of time to be right. As your contract approaches expiry, the premium on the contract will decrease.

* Volatility - you need to be wary of where you buy the options. E.g 1 week ago, the VIX would have been very high, since then it has contracted about 40%. You would have lost a lot of money, all else being equal.

* Option traders don't buy naked options, it is a losing strategy. They have an arsenal of strategies.

* Options are leveraged products, so you are not really comparing like for like. You are comparing 200 shares vs 10,000 shares.

* Commissions. In my world it is cheaper to trade options than shares. Don't trade based on commission. Find a strategy that works for you, and then worry about finding a broker that offers you the right price.


Having said that, I'd say better to trade options (with the right domain skills).

 

[wayneL]

Just to expand on what the others guys said, you are trying to compare two completely different TYPES of risk and reward as well as massively unmatched directional risk/reward.

An share position has a direct linear relationship with price movement. In your example, 200 shares will incontrovertibly win or lose $200 per $1 price movement.

As alluded to by the others, an option position is non-linear and risk/reward is measured by the Greeks, most notably, Delta, Gamma, Theta and Vega (there are others but these are the ones we retail traders are most concerned with). It would be foolish to go anywhere near options before familiarizing yourself with these. Options trades are inherently a bet on volatility as well as price movement of the underlying ( or non movement as the case may be.

But a loose directional comparison can be made in near price movement by matching Deltas in the two positions being compared.

If comparing 200 shares of longs stock (200 deltas) to say... at the money long call options, we need to construct a hypothetical position with 200 deltas. ATM call are approx 0.5, so 400 options are required for the comparison, i.e. 4 x long call contracts.

N.B. Option traders do sometimes buy long options, if that is the risk profile they want, but that will be just one risk profile out of many we might consider

 

[minwa]

* Option traders don't buy naked options, it is a losing strategy. They have an arsenal of strategies.

* Commissions. In my world it is cheaper to trade options than shares. Don't trade based on commission. Find a strategy that works for you, and then worry about finding a broker that offers you the right price.


Having said that, I'd say better to trade options (with the right domain skills).

Other points I agree but not these 2.

Lots of traders make money going long naked options. If you deem it as a 100% losing strategy then the reverse (selling naked options) would be a 100% winning strategy. Not the case, I'm sure many accounts were blown last week, while fortunes were made by naked options buyers.

As the OP is talking about ASX, shares are cheaper than options. Commissions AND dealing spread. ASX options liquidity are generally horrible.

 

[hhse]

Other points I agree but not these 2.

Lots of traders make money going long naked options. If you deem it as a 100% losing strategy then the reverse (selling naked options) would be a 100% winning strategy. Not the case, I'm sure many accounts were blown last week, while fortunes were made by naked options buyers.

As the OP is talking about ASX, shares are cheaper than options. Commissions AND dealing spread. ASX options liquidity are generally horrible.

* I hold my opinion that if all you are doing is buying naked options, it is a losing strategy. And I'm sure if grease implemented his long strategy in buying a call option to replicate his long stock strategy, he would have lost all his money.

* I hold my opinion that you need to find the right broker.

* Spread between bid and ask is valid in ASX markets. Overlooked that part. For that reason alone, I would not trade options in AU market.

 

[wayneL]

* I hold my opinion that if all you are doing is buying naked options, it is a losing strategy. And I'm sure if grease implemented his long strategy in buying a call option to replicate his long stock strategy, he would have lost all his money.

.

Sure, buts not quite what you said even though that's what you probably meant to say.

Just a matter of tidying up exact meanings in a complicated topic

 

[DeepState]

* I hold my opinion that if all you are doing is buying naked options, it is a losing strategy.

Can you please outline your reasoning?

 

[hhse]

Can you please outline your reasoning?

As WayneL advised, I'm listing out my assumption - this is in the context of replying to greasy's original post and should be interpreted in that context. i.e purchase of a stock, purchase of a call option. I'm trying to point out that there are differences, and options are not an appropriate fit.


* on average implied vol has exceeded actual vol

* you need to be directionally correct AND have the right timing AND the benefit you gain from delta needs to outweigh the loss in theta - too many ifs.

* Buyers are entering these as low probability trade (based off market probabilities)

There are more appropriate products/strategies out there to bet direction as opposed to only buying naked options.
And yes, my view point was extreme. So if you are successfully buying only naked options as your only strategy, good work and keep it up, no point fixing something that is not broken - but it is defintely something I've never done, and will never do.

 

[wayneL]

Just to add again: If we are going long calls instead of long stock (and matching deltas as explained), stock will almost always outperform calls when in a profit situation. Not only theta is working against you, volatility is also likely to sag. This will likely outweigh gamma unless you jag a massive move.

Puts are a little different, puts benefit from vol rush if it moves your way. Straight long puts are a great way to short the market (if you're right )

 

[brisman]

I think you've made a pretty good case for investing, not trading, in stocks over a longer term. Also you've made a case for having multiple option strategies, such as naked puts and calls last week, and selling credit spreads when the US market was flat prior to that over the last few months.

Why would you want to trade last week's extreme market movements with stocks when options were getting double or triple the premium?

 

[cynic]

I think you've made a pretty good case for investing, not trading, in stocks over a longer term. Also you've made a case for having multiple option strategies, such as naked puts and calls last week, and selling credit spreads when the US market was flat prior to that over the last few months.

Why would you want to trade last week's extreme market movements with stocks when options were getting double or triple the premium?

A quick glance at a VIX chart for the past year should furnish you with an answer to your question.

 

[brisman]

A quick glance at a VIX chart for the past year should furnish you with an answer to your question.

Last week, I wasn’t looking at the VIX graph and coming to a conclusion that stocks were better to trade than options. The VIX chart told me it was time to make profits on one of my long calls on UVXY:


3/8/2015 Buy to Open 1 UVXY Dec 15 10 Call $0.80 $14.95 $0.02 ($94.97)

24/8/2015 Sell to Close 1 UVXY Dec 15 10 Call $5.50 $14.95 $0.02 $535.02

(For those not familiar with UVXY it is an ETF that provides two times exposure to the daily performance of the S&P VIX Short Term Futures index. It may be used as a hedge.)

It’s hard to get a 563% return on amount at risk from shares in three weeks.

VIX did not get in the way of profitable options trading last week even though it rose so much. A future drop in VIX provides an opportunity as well as a risk.

 

[cynic]

Thanks for your response brisman, I'd been contemplating the possibility of formulating a trading strategy using VIX derivatives for much of the past year. Your mention of the possibility of using options over an ETF has given me some fresh ideas.

Do you mind if I ask which broker you're using?

 

[brisman]

Thanks for your response brisman, I'd been contemplating the possibility of formulating a trading strategy using VIX derivatives for much of the past year. Your mention of the possibility of using options over an ETF has given me some fresh ideas.

Do you mind if I ask which broker you're using?

I was with Interactive Brokers but due to it's limitations on margin, I've opened an account with OptionsXpress. OX is more expensive for smaller trades but has a good interface and education.

 

[minwa]

It’s hard to get a 563% return on amount at risk from shares in three weeks.

I don't think that's a fair comparison. On the risk side it's also hard for the shares to lose almost 100% of its value in 3 months time which the call option will if UVXY stays flat/down.

 

[sinner]

3/8/2015 Buy to Open 1 UVXY Dec 15 10 Call $0.80 $14.95 $0.02 ($94.97)

24/8/2015 Sell to Close 1 UVXY Dec 15 10 Call $5.50 $14.95 $0.02 $535.02

Soooo you're trading options on leveraged futures on options?

That is bound to end well

 

[cynic]

Soooo you're trading options on leveraged futures on options?

That is bound to end well

That would surely depend upon the trader's methodology and expertise, would it not?

Some subscribe to the philosophy that : "Know thyself and know thine instrument shalt be the whole of the law."

 

[brisman]

Yes I'm not saying everyone should trade options but if it suits you it can work well. Note that the leveraged trade is actually a hedge against volatility but it became very profitable.