How can options make more money than stocks if they are both based on the same thing?
In: Economics
Options are basically non-refundable but tradable deposits to buy a stock at a certain price by a certain date. They usually cost a fraction of the cost of the actual stock.
Say the stock is at $100 and you buy one share and it goes up to $110 a month later. You sell and you make $10
Say instead you can buy an option to buy the stock at $105 for $1 per share, with the option expiring in a month. You buy 100 for $100. The stock goes up to $110. You can then sell the options for $5 each (the difference between the agreed price and the stock price) so clear $400 profit. Yay!
On the downside – if the stock price is below $105 at the contract expiration the option is now worthless and you lost your $100 deposit. You haz a sad.
In other words – for a given amount of money an option contract gives you *temporary* control over a significantly larger number of shares, but at the risk that you’ll lose all the money you put down.
For someone who isn’t an investment bank trading options is, in effect, indistinguishable from gambling. And the “person” you’re betting against is a host of enormous investment banks with entire buildings full of math and economics PhDs working 80 hours a week to feed data to teams of some of the best software developers on earth who write highly optimized algorithms that run on special order servers that are located as physically close to the market as possible to reduce the number of microseconds it takes for the trading signals to travel from the computer to the trading floor, for a system that’s able to read and analyze any new market information and execute thousands of trades based on it in the time your computer takes to refresh a frame on your 144hz monitor. The way you make money against that betting opponent is to take significantly higher risks than them.
TL;DR: Options are a high risk form of gambling and while you can make money with them they are mostly a very efficient way to lose a lot of money very quickly.
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