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What Is Option Trading Risks?
The probability of a loss of capital through stock option trading.
Option Trading Risks : The Offical Word In Short
The option trading risks specified by CBOE pertaining to stock options can be summarised into the following main points:
1. Naked options positions has unlimited loss potential.
2. Options can expire out of the money and worthless. (thus all the money you put towards purchasing them)
3. Options leverage can work against you as much as it can work for you.
4. Obligations and rights of buyers and sellers.
5. Terms, conditions and policies of the specific option contract, options exchanges or options brokers can change at anytime.
Every of the above option trading risks can result in a catastropic loss of capital, that is why you must fully understand stock options as a
financial instrument so that you can lower the option trading risks posed by the above.
Option Trading Risks : 3 Macro Risk Factors
There are 3 macro risk factors which applies to any investments on the stock market and are not option trading specific.
Primary Risk (Market Risk)
Primary risk or Market risk is the risk that the overall market failed to move in your expected direction.
Secondary Risk (Sector Risk)
Secondary risk or Sector risk is the risk that a whole sector of stocks failed to do well.
Idiosyncratic Risk (Individual Stock Risk)
Idiosyncratic risk is the risk that shares of a company you bought is effected by events that happens to that particular company.
As you can see from the above, there is no way to totally eliminate option trading risks.
Option Trading Risks : Directional Risk
Perhaps the next most signficant option trading risks that affects most option traders is Directional Risk or Delta Risk.
No matter what option strategies you choose to execute,
the underlying stock needs to behave in the manner needed for that particular option strategy to turn a profit. For example, if you execute a
Bull Call Spread on XYZ company's stock, then that
stock needs to rise before you can turn a profit. If your prediction is wrong, you can still lose money.
Option Trading Risks : Other Less Significant Risks
Apart from the Delta Risk mentioned above, option traders also face other option trading risks such as gamma risk, rho risk, vega risk and theta risk. All of these risks are
represented by the option greeks and can be hedged away using spread strategies.
Please read How Stocks Can Be Riskier Than Options.
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Important Disclaimer:
Options involve risk and are not suitable for all investors.
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