Is Options Investing Safe?

Imagine standing in front of a playground with two choices: you could swing gently by yourself, pushing with your legs at a comfortable pace, or let your enthusiastic friend push you toward the sky. The first option feels safer but limits how high you can go. 

The second offers thrilling heights but comes with more dramatic ups and downs. This is precisely the difference between investing in stocks and options.

While most investors understand stocks, options often trigger anxiety. According to recent FINRA studies, over 75% of retail options traders lose money in their first year. 

But these statistics don’t tell the whole story – they combine both short-term traders and long-term investors, two groups with vastly different outcomes.

Understanding Leverage: The Double-Edged Sword

Think of leverage like that friend pushing your swing – it can help you reach higher heights, but it also means more dramatic swings in both directions. This is the fundamental nature of options as leveraged investments.

The Risk-Return Relationship in Options

When you invest in options, you’re essentially making a trade-off: accepting higher volatility for the potential of enhanced returns. Here’s how this works:

• A stock might move 1% in a day, causing a $100 investment to change by $1
• An option on that same stock might move 3-5%, turning that $100 into $103-$105 (or $95-$97)

This increased volatility isn’t inherently good or bad – it’s simply a tool that must be understood and managed. As veteran options investor Mark’s experience shows: “I used to fear volatility until I realized it was just another variable to measure and manage, like any other aspect of investing.”

Measuring and Managing Volatility

Professional options investors follow a simple principle: higher risk demands higher potential returns. They:

1. They take a look at where the option’s implied volatility is trading now versus where it has traded in the past
2. Determine if the potential return justifies this risk level
3. Size their positions accordingly and/or alter their option strike prices to lower or raise exposure to the volatility
4. Use longer expiration dates risk when buying and shorter expiration dates when selling

The LEAPS Advantage: Time as Your Ally

One of the most powerful approaches to safer options investing involves using Long-term Equity Anticipation Securities (LEAPS) – options with expiration dates a year or more in the future.

Why Time Matters in Options Investing

Consider Sarah’s experience during the 2023 market correction. While short-term options traders panicked as their positions approached expiration, her LEAPS expiring in January 2024 gave her the luxury of time. She explains: “When you have 23 months until expiration, temporary market downturns become opportunities rather than disasters.”

Key benefits of LEAPS include:

• More time for your investment thesis to play out
• Lower impact from short-term market volatility
• Reduced time decay in the early months of the position
• Greater flexibility to adjust your strategy

Building a LEAPS Portfolio

A successful LEAPS strategy typically involves:

1. Selecting companies with strong fundamentals
2. Choosing expiration dates 12-24 months out
3. Focusing on quality over quantity in positions
4. Understanding how to pick strike prices to give you a leverage level with which you feel comfortable
5. Having patience during market volatility

The Risk Management Framework

Success in options investing requires a clear understanding of when and how to use these powerful tools.

I think of a portfolio that contains stocks and options like a meal. Stocks represent the staples and proteins, options represent the spice and flavor.

When to Use Options: Options provide spice and interest to the main dish of the stock investments

Options are particularly valuable when:

1. Hedging: Using puts to protect your portfolio during uncertain times
2. Income Generation: Selling covered calls or short puts on strong companies
3. Capital Efficiency: Using LEAPS instead of stocks for long-term positions
4. Strategic Entry: Selling puts to acquire stocks at desired prices

Stocks are a “Staple” for an intelligent Option Investor’s Portfolio

Stocks offer:

• Generally lower price volatility
• A “perpetual” investment that does not periodically expire
• Dividends that effectively reduce your buying price over time
• Conceptual simplicity, deep markets, and easy pricing

Practical Implementation: The Safe Approach

Let’s examine how successful investors implement these principles in practice.

The Conservative Options Portfolio

Consider David’s approach to building a safer options portfolio:

1. Core Holdings: 70% in stocks and bonds
2. Protective Puts: 5% allocated to portfolio protection
3. LEAPS Positions: 15% in long-term options on quality companies
4. Income Strategies: 10% in covered calls and cash-secured puts

Risk Management in Action

His rules for options positions include:

• Only investing in companies with strong fundamentals
• Using LEAPS for major positions and overlaying them on the stock positions in which he has the most conviction
• Limiting individual position sizes
• Maintaining cash reserves for adjustments

Moving Forward Safely

Understanding options investing isn’t about eliminating risk – it’s about managing it effectively while pursuing your investment goals.

Educational Foundation

Our free introductory course teaches:

• Understanding leverage and volatility
• Measuring and managing risk
• LEAPS strategies for long-term investing
• Portfolio protection techniques

Advanced Strategy Development

The fundamentals bundle builds on these concepts with the following:

• Advanced risk measurement tools
• LEAPS portfolio management
• Volatility analysis techniques
• Comprehensive hedging strategies

Conclusion

Is options investing safe? Like that playground swing, it depends on how you use it. With proper education, risk management, and a focus on longer-term positions like LEAPS, options can be valuable tools for both protecting and growing your wealth.

The key is matching your strategy to your risk tolerance and investment goals. If you’re ready to learn how to use options effectively, start with my free course to build a solid foundation. When you’re comfortable with the basics, my Fundamentals Bundle will help you master advanced strategies for long-term success.