February 21st, 2012
Options are a good way to play the market with leverage. I have had many days where I have more than doubled my premium in a single day. Of course that goes both ways. I have lost more than the entire premium in a day more times than I care to think about. There are ways to enhance your chances of winning.
I prefer to sell options as opposed to buying them. Since options have an expiry date, they are a wasting asset, unlike the underlying security. This time value is called "decay". The more time left, the more it is worth. The closer it gets to expiry, the faster the decay.
Thanks to trading-plan.com for the chart.
As you can see the 30 days and less have a rapid decay. This is why I like to sell one week options. You would think that no one would buy these, but I trade them weekly with Market Vectors Gold Miners (GDX) and others, and have had great success. GDX is a gold ETF that holds the stocks of Barrack Gold Corp. (ABX), Goldcorp Inc. (GG), Newmont Mining Corp. (NEM), Yamana Gold Inc. (AUY), Kinross Gold Corp. (KGC) and many others. It has enough liquidity to make it easy to get in and out of contracts.
There is another reason to sell options as opposed to buying them. The chart below shows as a percentage how many option trades expire worthless.
As a seller of the option this is good news. If three out of four contracts expire worthless, wouldn't you like to be betting on the three out of four the seller gets vs the one out of four the buyer is getting?
Conclusion: In my opinion short term options are not a good choice to buy, but enhances your chances at success when you sell them.