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Sunday, September 24, 2006

My Trading Style (Part 1)

Someone once asked me if trading options is easier than trading stocks. And my answer is a big NO, even though I have not had much experience trading stocks. Therefore, I like to keep my trading style simple or as some say the 'KISS' way (Keep It Simple & Stupid. Options itself is already a complex instrument, so why make it even more complicated?

Before I go on, I'll like to explain why I feel that options trading is tougher than stock trading:

-Direction: Ok, this is the only element which both stock trading & options trading need to get it right to make money. And the similarity ends here.

-Timing: Options have the element of time decay, which means that as time passes, the value of options will fall assuming all things constant. Thus its useless if you, as a buyer, gets the direction right but the timing wrong in options trading. Assume the stock price moves in a sideways manner after your purchase and the expected move only occurs 6 months later. Your option which say has a 3 month maturity will expire worthless. But for stocks, you can hold the position for as long as you like for your expected move (though there is opportunity cost involved or interest incurred if purchase was made on borrowed money). In options trading, you are fighting against time.

-Magnitude: In stock trading, as long as the stock price goes in your direction, you'll make money, even if the move is only 10 cents. In options trading, if stock price goes in your direction, but the move is not large enough to cover time decay, you are still on the losing end as a buyer.

You are out of the game if you don't get these 3 elements right. And as a matter of fact, you WILL find yourself out of the game fairly often, which is why money management is extremely important if you are in this for the long run. I'll talk more about this later on.

Well, since options trading is more difficult, why do you choose it you may ask. For the following reasons:

--Limited dollar risk and exposure: As an options buyer, one can control the stock for just a fraction of the cost of buying that stock. Also, one can never lose more than his purchase price of the option. I must say this attracted me to options trading in terms of feasibility, because I don't have a deep pocket to start with.

--Leverage: Options trading can provide larger % gains. A $5 move in a $50 stock represents a 10% profit, but if you have participated in terms of options, the % gain would be phenomenal, much much higher than 10%!

--Versatility: One can profit whether in Bull or Bear markets. You can make money in a bear market by purchasing put options, which increases in value as stock price declines. And in a bull market, call options behaves pretty much like stocks, except with more leverage. This is the beauty of options.

To be continued...

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