Options Trading: What Are the Risks?

By Patricia Uceda, Spring 2015 Graduate Research Assistant

Now that you’ve learned a little bit about options and the common terminology used in options trading, it’s time to learn about some of the risks associated with this type of investment. Like other investments, options carry no guarantees.  Losing all of your initial investment is always a danger. There is even a bigger danger in options trading than in securities investments:  with options there is sometimes a risk of losing more than your initial investment.

Here’s how the SEC explains the risks in its Investor Bulletin: An Introduction to Options:

“What are some of the risks associated with trading options?

 

Options like other securities carry no guarantees, and investors should be aware that it is possible to lose all of your initial investment, and sometimes more.  For example:

 

Option holders risk the entire amount of the premium paid to purchase the option.  If a holder’s option expires “out-of-the-money” the entire premium will be lost.

 

Option writers may carry an even higher level of risk since certain types of options contracts can expose writers to unlimited potential losses.

Other risks associated with trading options include:

 

Market Risk – Extreme market volatility near an expiration date could cause price changes that result in the option expiring worthless.

 

Underlying Asset Risk – Since options derive their value from an underlying asset, which may be a stock or securities index, any risk factors that impact the price of the underlying asset will also indirectly impact the price and value of the option.”