When NOT to use Option (Calls or Puts)
Introduction
Markets are exploding everywhere, I guess this might be the right time to provide some sort of insights or guidance how to manuver the financial markets at these turbulent times.
Article format
I plan on making short, rapid blog posts and keep them compact instead of long ass boring articles. Who here reads the entirety of a financial statement? I mean full 100% of an FS? That is called wasting time, focus on 5% of the most important key highlights will yield similar conclusion and that is what I'm planning to do with these short financial series posts.
Option (Call / Put) - theory
For a full theoretical explanation please do a proper research! DYOR. TLDR: Imagine you're buying an insurance policy for your house or your automobile, that's an Option! So it's a derivative contract where you have the right to Buy (Call) or Sell (Put). We pay option cost (known as premium) with the following equation:
Premium = Intrinsic Value + Time Value.
Main use of Option
Hedge: instruments to protect the value of investments. (Proper) Institutional investors mainly use Option as hedge instrument.
Speculation: instruments to make a bet on the market. Retail investors loves using Option to speculate and some institutional investors do it too albeit with much stricter capital allocation.
Ideal time to use Option
When to use: before the Event (whatever that is: Trump announcing trade wars, J.Powell cut interest rate by 100 bps, etc). This is why most institutional investors views Option as insurance policy, they've set a small portion to continuously buy Option. Who knows what kind of disaster is looming on the next turn?
When NOT to use: at the Event. There is one major factor called Volatility that will decide whether you make money or lose money on the Option trade. Being reactive and buying Option when things are exploding might be one of the worst mistake an investor can do, as the jump in Volatility would have been builtin into the Option premium so you're paying far too much for your Calls/Puts. In the financial markets, pricing is everything.
And remember your C/P has an expire date, so it is a decaying asset meaning it's value will keep on decreasing as time passes by. So in a scenario where you buy Option when things are exploding, then after that markets have settled --> you'd have lost so much money from your Option trade, hit by what's called a Volatility Crunch (a sudden jump in Volatility (when markets craters), followed by sudden drop when the markets have calmed down).
Conclusion
If you've just thought of buying some insurance for your house when the tornado is in front of your eyes, then it's too late already. I'm not saying it's impossible to make money, but it's very difficult and you end up exposing your financials to a much greater risk that you don't need to take in the first place!