“Investing” involves some risk, but it also relies on a realistic expectation of returns. Selling an out of the money stock option is an investment, since, all things being equal, the value of that option will decay over time. You can then buy it back for less than you sold it or let it expire worthless. Purchasing a dividend paying stock in a strong, successful company is another type of investment. A stock can take a dive or stop paying dividends, just like a short option can go in the money. However, the odds are at least slightly in your favor when you do these trades, and if you buy several quality stocks (with diversity!) or sell several different out of the money options, the law of large numbers is on your side. Keep rolling that loaded die and you will win more than you lose.
Speculating, on the other hand, is a form of gambling. I will admit that I have one contract of a speculation in my trade account. The position cost me under twenty dollars to enter. That is not any sort of trade lingo, it literally cost me under twenty dollars; less than my husband and I spend on a dinner out. The rest of my portfolio consists of investments, the best of which are short stock options that are currently out of the money (I’d better check on that lest I jinx myself by saying it). Yep, my good little underlyings seem to understand the word “stay” better than my dog does. If I could make them “lie down” and “play dead,” I’d make a fortune selling calls and buying puts. But I digress.
My speculation is a long call on a small tech company. The call is slightly out of the money, and if the stock does not go up and the volatility stays the same, my call will expire worthless. I have no good reason to think it will go up, other than the fact that they company has a potentially successful drug compound in the pipeline. Of course every little tech company has something going for it, so there is no reason to expect this one to be special. I’m betting on it, but I have no illusions about the risk I am taking. Buying that call was no different than placing a bet on a certain team to win the NCAA tournament.
Speculators can win big. My call is a LEAP, meaning the expiry is far in the future. If the stock skyrockets for some reason, say to $10/share, then my little 2.5 call would get me $750 dollars profit (not including commissions). That’s a 3,700% profit. Nice!
Realistically though, I’ll be lucky if the stock goes up enough that I can make get a couple dollars profit after commissions. I think that has a good chance to happen or I wouldn’t have purchased the call. However, I did it more for fun than for profit and will be pleased if I make anything on it rather than disappointed if I don’t.
Speculating is not a good way to build wealth or make a living. Those who count on speculations to pan out will often experience both wealth and abject poverty in that order, which is sad. It’s ok to speculate occasionally, just like it’s ok to bet on a sporting event in an office pool or blow fifty dollars in a casino on a trip to Las Vegas. (Yes, I mean fifty dollars net loss on the entire trip. What can I say? I’m not big on gambling.)
Make sure that your portfolio consists primarily of investments and don’t count on speculations any more than you would count on winning the lottery. Understanding the difference between a speculation and an investment is one of the big differences between a professional trader and someone who has to work because his portfolio is insufficient to sustain him.