Trading options isn’t easy. It is important that investors understand them clearly; if they don’t, they could lose their entire investment, be faced with heavy losses, or end up with a position they never really wanted in the first place if the trade doesn’t work in their favor.
Knowing what kind of options to buy is just the first step. There are many other factors investors have to consider before entering the trade, including the following three considerations:
Keep the Bid and Ask Spread Small
When it comes to stocks, thanks to liquidity in the stock market, the bid and ask spread—the difference between the price buyers are willing to pay (bid) and sellers are willing to sell for (ask)—is usually within $0.01. When it comes to options, this range can be very wide; at times, this range can be more than $0.25.
The bid and ask spread matters because it affects the money you are putting into options. At the very core, a big bid and ask spread can result in losses. For instance, if the bid for an option is at $0.10 and the ask price is at $0.20, an investor will pay $20.00 to buy on contract. If they go right away to sell, they will have to sell for $0.10, or $10.00 per contract—this results in a loss of 50% per option.
Choose Limit Orders Over Market Orders
When an investor places a market order, it essentially means they are buying at the available price—which generally means they receive the ask price. This can have two consequences: first, if the spread is big, they will see … Read More
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