Have you ever been tempted to buy low-cost options for your favorite stock? Many new options traders are intrigued by this move. But not all options traders realize how much of a long-shot these options are, or how risky this can be. Here’s why (and what you might consider trading instead).

These options are cheap for a reason. I explain why in this post, part of my series on volatility crunch.

Don’t be tempted to buy a lot. It’s one thing to plunk down five bucks on a lottery ticket; it’s another to spend $50. You’re not meaningfully increasing the odds of success on this trade by buying more of these options. You are, however, putting more capital at risk on a hail-Mary trade with a low probability of success. Manage your trade size with this in mind.

For your first options trade, consider covered call writing instead. Many new options traders are tempted to buy low-cost calls as their first options trade because it’s familiar to you as an equities trader: buy low, sell high. But they don’t always realize this trade has such a low probability of success when they’re doing it.

Download these two free Intelligence Reports to get a few more viable ideas for your first options trades: Top 10 Mistakes New Options Traders Make (PDF) and Five Tips for Successful Covered Call Writing (PDF).

Bottom line: it’s fine to trade in lottery tickets, just stay realistic about the odds. One of the top performers on TradeKing’s Leaderboard likes to dabble in low-cost LEAPS options around specific future news events, which stacks the odds slightly more in his favor.

The size of move the stock needs to make in these situations usually stacks the odds against you. TradeKing’s Probability Calculator (under Tools) can help you estimate the probability of a stock reaching a certain number, so if you’re dabbling in lottery tickets you’ll go in with your eyes open.


Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com

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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options available at http://www.tradeking.com/ODD.

Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.

TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.

(c) TradeKing, Member FINRA, SIPC. http://www.tradeking.com

Reading this reminded me of an option play I ran on MCGC a while back before the market tanked.  I put up $20 on a call option that was OTM, but things moved in my favor before expiration and I was able to exit and double what I put down.  One thing to watch when doing plays like this is the option's delta.  The lower the delta, the less likely you will exit with a profit.  I do agree that the best way to dive into options is to write calls on your existing portfolio.  The only risk here is opportunity cost if the stock soars higher than your call's strike price, thus limiting your upside profit when you get assigned.

With options one has to be concerned about time,direction, and speed.  Get any three wrong and you loose.


For me I always go for deep in the money options for a directional play so I capture at least 80% intrinsic value and go out a couple of months out so I have time.  Even though these are more expensive it is still cheaper than just buying the stock if I am very bullish or bearish.  The big thing though I reduce my theta decay each day. 

More often than not I put on a directional calender or out of the money butterfly so I am positive theta and can get out cheaply if the trade goes against me.  Much easier to manage too.

I agree, covered writes or directional diagonals are great plays for beginner and experienced option investor.