The US stock market has finished the first quarter on a high, with the S&P 500 clocking in about a 7% year-to-date gain.
Yet the jury is still out on whether the market has turned a corner and is in a bullish rebound or is about to slump back deep into bear territory. Fears of the long-awaited recession and recent banking instability still abound.
Most passive and value investors require a sustained rise in equity prices to stay in the green. Yet those who trade options can pocket a profit even during a downturn. Fixed-term futures contracts (or options) can deliver outsized profits during bull runs but can also be used to bet against the market and become a honeypot for the bears.
There has been a surge in options trading since the pandemic, with more investors using the added flexibility from the tool and the diversity of trades available to profit from the wild market swings seen since that world-changing black swan event. Even now, with the pandemic firmly in the rearview mirror, options trading remains robust, suggesting the trend may go on deeper into the decade.
This article will consider what’s driving the soaring popularity of options trading in recent years, highlight some of the unique aspects of these contracts and look at how to get started as a beginner options trader with this unique asset class in 2023.
We Like Our Options
Recent years have witnessed an options boom. Before the pandemic, the annualized average of total daily options trades barely scratched 20 million. In 2021 that figure reached 39 million, and last year it surpassed 40 million.
Options trades from institutional investors increasingly have the momentum to move markets. For instance, the JPMorgan Hedged Equity Fund – which manages nearly $15 billion in assets – resets its hedges at the end of each quarter, which can exacerbate daily volatility on the day of the reset.
In particular, the rise of ultra-short-term contracts, known as “0DTE” (or “zero-day to expiry” options), has taken on an among day traders looking to price in before the close of trade, especially those tracking market sentiment, like S&P 500 0DTEs.
All options ensure the right to buy or sell equities at a certain price at a given time, but 0DTEs expire the same day they are purchased, enabling profits from intraday price moves. These plays can be particularly lucrative when timed for Fed days or monthly inflation data releases, which usually swing the market.
According to OptionMetrics data, the daily volume of 0DTEs trades almost quadrupled between the start of 2020 and late last year.
Asset Class of Their Own
Used effectively, options investing can deliver an edge for investors over regular stock trading. Traders can customize their options contracts to reflect their risk profile, hedging against losses with stop orders while also multiplying their potential upside returns with leveraged calls.
Yet, unlike traditional stocks, options contracts expire, which can lead to full-scale losses if not exercised properly. This is why options education is so essential. Investors who don’t really grok core concepts like “strike price” and “time decay” before they wade into the market won’t last long.
For newcomers, the steepest part of the learning curve is mastering complex concepts and understanding how they interrelate with one another. Options trading is not as intuitive as a simple buy-sell formula, and the factor of time changes the risk calculus.
Some may see the potential big wins and total losses as bordering on gambling. Options may use leverage, but that doesn’t make them purely speculative per se. Certain contracts can be designed to generate passive income and act as a hedge against losses in stock positions. Getting the greatest value out of options requires harnessing the myriad combinations of contracts available.
Weighing Up Your Options
There are a number of entry points for options trading. For newcomers, there are a number of reputable online trading courses that can deliver the knowledge needed to get started. Most of these courses are found on investing websites or ed-tech platforms, and some mentors also teach simple strategies that have been historically profitable. Although, it is crucial to note past performance cannot guarantee future results.
As you become more experienced and start to master the basics of call and put contracts, you can experiment with more complex options and strategies. Some of the more popular plays have memorable monikers, like “wheels,” “iron condors,” “butterflies,” or “straddlers.” While none of these are magical fail-proof plays, their diversity reflects the inherent versatility of options contracts. This flexibility enables investors to settle on a strategy that suits their risk appetite and trading style. Once they become familiar and comfortable with the strategy, they can tweak it to optimize their results.
As it continues to evolve with today’s ever-changing investment landscape, options trading has become a popular way for traders to seek out leveraged trades and beat market averages. Armed with the right education and a prudent strategy, options trading can be a worthwhile undertaking.
This article was produced and syndicated by Wealth of Geeks.
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