Optionetics Mentoring Program - Lesson 2

Our lesson this week has been an “Introduction to Options”. The workbook explained the basics of options, which I won’t go into in any detail. We are starting to do better with the vocabulary. It’s one of those things that we need to have a good understanding of, but I think that we will only really grasp some of these concepts once we start working with them. We have been watching the DVDs that came with the Wealth Without Worry series to help round out our introduction.
Risk Graphs
Both the DVD and the workbook introduced the concept of Risk Graphs. I’m guessing that Risk Graphs are a tool that Optionetics uses a lot. I like to see things visually, so graphs are a good thing. The main concept shown on the graphs is the fact that options limit your risk to the price of the option. If you buy an option for $2/share, the trade can go in the opposite direction from what you expect and you still can only lose that $2. That protection comes at a price, though. If the price of the underlying stock does not move at all, you still paid the price for the option, so you have lost the price of the option. That means that the price of the underlying stock needs to go up by an amount equal to the price of the option before you start making money. My biggest concern at this point is that with options (at least with buying a call) you not only have to be right about the direction that the stock is going to move, it also has to move enough to pay you back for what you’ve paid for the option before you make a profit. It seems like you would get similar protection by using a stop/loss without the additional cost. With a stop/loss you have the potential that the price will gap through your stop/loss level, so you could potentially lose more than what you had planned for, but I’m not sure that the additional risk is worth the price of the option. We will have to see how they put together strategies.