You can spot bad advice really easily. I found this blog a few minutes ago while putzing around on the internet on my lunch break.
These days there are many blogs that cater to new people wanting to make fast cash in the world of investing. There’s no such thing as making fast money in the Capital Markets. Even the best investors like Soros & Buffet know this. If you go into investing wanting to make fast money, you’re going to end up being reckless. The main problem I have with this article is that it doesn’t address the risk, and the call option example they use is not accurate. Wall Street will always have more information about companies than main street. They have analyst working 24-7, so they will know of any new product releases. So it’s going to already be priced in the stock by the time the news announces it to the world.
Think of an option as a bet that has a time requirement. For example, let’s say the Lakers are down in a the finals, and there is 30 minutes left in the game. The score is 55 – 85.. You place a bet that cost you $2,000 that their score will go up within the next 5 minutes. You could also make more on your money if you bet that they will score 10 points in the next 5 minutes. There are a few things going against you. One is time. Each tick of the clock eats away at your $2k investment. Each tick of the clock as it gets closer to 5minutes accelerates the rate at which it eats away at your money. If the Lakers don’t make some points fast in the next 5 minutes you lose all of your investment. The price of an option that you purchase has a time value placed into it. Let’s use the apple example from the article, but use apple’s current price. Let’s say you want to buy a three month call on apple. A share of AAPL at this moment is $351.69. To buy the May $350 option calls at this moment, you’re gonna have to put down $2,185.00 large. That’s the price to put down one bet that AAPL will go up from this price of $350.69. A mathematical model is used to determine this price. It’s complicated. The important thing to know is that $2,185.00 has the 3 month time value factored into it. This is called THETA or Time Decay. If you want more time for your option, such as a 6 month option it will cost you more. You’re giving yourself more room for error and the probability becomes higher that AAPL will move in your favor. Essentially, you’re making a bet on AAPL’s price, direction and the time that it will move. So in three months Apple has to go up for you to make money. If you’re thinking at this moment that “oh it definitely will”. You’re getting owned by hindsight.
If AAPL just sits around and moves sideways at $350.00 for the next three months you will lose money on your investment, b/c of Theta or time decay. Yes, this isn’t like a stock. Options lose value every day b/c their price is made up of time. Each passing day they lose value to where they eventually expire worthless. Also, time decay of an option has an acceleration value which increases each day. So each day time decay is eating away at your $2k investment faster. Kinda like life…ha! Options are like life. That’s so deep! ok, I’ll stop the lameness. So ya, Theta/Time Decay is like the acceleration of gravity 9.86 meters/second squared. Each second acceleration increases 9.86 meters. That’s the same w/ time decay but at a different value of course which is determined by mathematical models. So, if AAPL decides to go down or move sideways from the price you purchased it for the next three months, you will lose all of the $2,000 at options expiration. See not that easy right. You gotta be right on the price and the time of the stock. It’s possible to make money in options. I mean there’s a reason why you see the same poker players in the finals all the time. ~Frank Slaughtery 2.0