Macro and Micro Risk Factors

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Chapter 17 — Macro and Micro Risk Factors
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Macro and Micro Risk Factors

Macro and Micro Risk Factors

There are also two main types of risks involved with options trading. Risk factors that come with any type of trading (called Macro Risk Factors), and the unique risk factors that come from trading options (called Micro Risk Factors). To trade options successfully, you will need to be aware of the risk factors you are facing. Overlooking too many risk factors for too long will eventually cost you money as an options trader.

Macro Risk Factors

Macro risk factors are the risk factors that come from the price movements in the underlying securities that are tied to your options. There are three macro risk factors: Primary Risk (Market Risk), Secondary Risk (Sector Risk), and Idiosyncratic Risk (Individual Stock Risk). Primary Risk is the risk that the overall market did not move in the direction that you predicted. Secondary Risk is the risk that the sector focus of your options does not move in the direction you predicted. Idiosyncratic Risk is the risk that the individual stock behind your option does not move in the direction you predicted.

In general, macro risk factors can be thought of as the risk of making an incorrect market prediction. These are risk factors that you will face with any type of investment or trade.

Micro Risk Factors

Micro risk factors are the factors that will affect your overall portfolio based on the nature of options contracts. The risks involved with these contracts are different for options buyers and options sellers.

Risks to Options Buyers (Call Options)

Call options buyers have a few unique risks: As an option buyer you have the risk of losing your entire investment in a short period of time if the option goes out of the money and as the expiration gets close. The risk of being unable to sell options with low levels of liquidity. And the risk that exercises provisions might make a correctly anticipated trade unprofitable.

Risks to Options Sellers (Call Options)

Call options sellers (or writers) face a different set of risks: Options that are sold can be exercised at any time, creating losses in a trade that could have otherwise been gain. Covered Calls traders give up the right to profit when the underlying stock rises and continue to risk losses in their stock investment. Naked Options writers can face unlimited losses when the trade moves against them. And options writers are obligated by their contract even if there is no market for the underlying security. 

Overall, options sellers face higher potential losses than options buyers.

Quiz

What is a risk that is unique to a call option writer?

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0/76 (0%) Correct
  • 1
    An option can be exercised at any time.
  • 2
    The overall market didn’t move in the way predicted
  • 3
    The market sector didn’t move in the way predicted.
  • 4
    It may be difficult to sell an option with low liquidity.
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