- Loss of the option premium
As a buyer, you need to pay the option premium upfront. If the option expires with no intrinsic value (meaning the price of the underlying asset is below the strike price for a call option or above the strike price for a put option), the option becomes worthless, and the buyer loses the entire premium. In simple terms, if you bought a call option expecting the price to rise and it doesn’t, or a put option expecting the price to fall and it doesn’t, you lose all the premium. This is the biggest risk.
- Time value erosion
Options are contracts with a limited time frame, and the time value diminishes as the expiration date approaches. Even if the underlying asset’s price fluctuations meet expectations, if the volatility is insufficient or occurs too late, the option buyer may still be unable to profit. This erosion of time value is unfavorable for buyers. The closer the option contract gets to expiration, the more disadvantageous it becomes for the buyer.
Example: You are optimistic about the short-term increase of XX stock, so you purchase a call option that expires in three days. On the first day, you buy it at $9 (the cost price), but the volatility is low, and there isn’t enough profit. By the second day, with the underlying asset’s price remaining relatively stable, your option contract is closer to expiration, causing a significant decrease in time value, leading the opening price of the option to only be $6 (the current price). You have effectively lost 33% due to the erosion of time value. Subsequently, the underlying asset rises, and the option also increases as expected, but the extent of the rise cannot recover the loss of time value ($3), ultimately resulting in a loss for you. Time value significantly affects the current price of the option. This is also one of the reasons why people fear options that are close to expiration.
- Insufficient market volatility
Market volatility is one of the critical factors influencing option prices. If market volatility decreases, the value of the option may also decline, leading to losses for the buyer. Even if the price of the underlying asset moves in the expected direction, a lack of volatility may still prevent the buyer from making a profit. In simple terms,
- Implied volatility change risk
The price of options is impacted by implied volatility. If the market’s implied volatility decreases, the price of the option will also fall, which results in unrealized losses for the option buyer.
In summary, as a buyer, you initially pay the option premium, and if there’s no chance to earn it back, then this cost is essentially wasted; additionally, you have to worry about time value, volatility, and other factors that influence the price of your option. Therefore, as a buyer, the probability of success is naturally lower, and the difficulty of making a profit is relatively high. Consequently, although options provide endless opportunities to earn money, there are some thresholds to cross.