What YouTubers Don’t Tell You When They Tell You to Trade Options

As more people are working from home during the pandemic, a lot of investment YouTubers emerge. More and more people are taking advantage this chance to learn from these investment YouTubers and manage their own investment account. What I find concerning is that a lot of these YouTubers brags about how much money they can make. A lot of individual investors will just try to copy what they do and put themselves in a very risky scenario.

A extremely concerning issue is people’s view on stock options. A lot of YouTubers actually are telling people to trade stock options, and they usually get outstanding performance. Options can get them hundreds of percents of returns within a week. Some people will take stock options as their way to financial freedom. The problem is that when some YouTubers are bragging about their track record and promoting option trading, they only highlight how much money they can earn, but they do not mention how much they can lose. I hope this article can help you understand the riskiness in vey simple option strategies.

Call Options

Options allow investors to buy or sell a certain stock at a specified strike price. For example, a call option on TSLA with a strike price of $700 allows the investor to buy Tesla stocks at $700 per share at the expiration date of the option. A put option with the same properties allow the investor to sell at $700 per share at expiration.

Call options are so called “bullish options” — you earn a profit when the stock price increase. Hell no! It is not that simple. Let me use some real numbers to demonstrate.

Tesla closed at $677.02 today (4/9). Many call options with different strike prices being traded at the same time. I collected the price of a part of the available strikes ($640–$710). Strikes are:

4/9 is a Friday and usually options expires on Fridays. Look at the price of the options with different strikes. The summation of the strike price and the option price is very close to $677. Take the $640 strike as an example. $640+$37.25 is $677.25. If you purchase the option, you have to spend $37.25 per contract, and you have to buy 100 contracts each time. So you spend $3,725. What do you get in return? You can buy Tesla stock at $640 per share. What’s your average cost if you actually use the option to buy Tesla stock? $677.25 per share. Higher than the market price. You would be better off just buying at the market price.

Let’s then look at some options that expires in the future. As you probably have noticed, the option price increases as the expiration date goes further into the future. Let’s take $640 strike and 5/7 expiration as an example. Today, if you buy the option for $6,625, you can buy Tesla stock at $640 per share for 100 shares on 258 days later. If Tesla stock price goes up to $700 per share, do you profit at expiration? No! Your average price will be $640+$66.25=$706.25 and Tesla worth only $700. You lose $625 for the 100 shares of Tesla.

Let’s now look at the options expiring more than 2 years later. Options with $640 strike are no longer available. If you invest in the $650 call, Tesla stock price needs to be at least $268.55+$650=$918.55 2 years later for you to profit at expiration. Going up is not enough to make a profit investing in options.

So, what’s my profit and loss?

If you invest in the very long term option and wait for 2 years, what will the return look like?

• If Tesla’s stock price reach $1,000 at expiration date, you will be buying Tesla at $650 and earn a difference of $350. You invested $268.55 for the option. So your return will be
  ($350-$268.55)/$268.55=30.33%
  If you spend the same amount of money on stocks, you get
  (1000–677.02)/677.02=47.71%
• If Tesla’s stock price dose not change and stays 677.02, 2 years later, you can use the option to buy the stock at $650 and sell at $677.02 for a difference of $27.02, but you spent 268.55 for it, so your return will be
  ($27.02-$268.55)/$268.55=-89.94%
  If you spend the same amount of money on Tesla stock, you end up with 0% return.
• The previous 2 examples are already pretty surprising, but if Tesla stock price goes below $650 2 years later, then you lose all the money in option because if Tesla’s stock price is $640 and you still use the option to buy the stock, you lose $10 per share right there. This option becomes worthless.
  If you spend the money on stocks, then you lose $10 per share and it is about 1.5%.

Options do not necessarily give you better return.

What about short term options? Here is a p/l chart for the $650 options expiring on 5/7.

Investors buying options will breakeven when the stock price is about $710 and better off is the price of Tesla goes above $714 per share.

So what are you buying when you are buying an option?

When you are buying an option, you are literally just buying an “option”. This option allows you to lock in a price (strike price) for a certain period of time. The price of a call option can be high for two reasons: the strike is too low (as the option is too good) and the expiration date is too far away.

From the above examples, investors can be better off investing in options only when the stock price goes up a lot. In other words, there are “unexpected” increases. However, what’s the probability of that?

Thank you for bearing with me. All in all, I hope this article is useful. Options can give you great returns, but it has to be driven by large (or less likely) price movement in the underlying stock. Then this is a game of probabilities.