These Aren't the Multibaggers You're Looking For

If you manage to find the truly great investments, it's entirely reasonable to expect multibagger returns over the course of 10 or 20 years. But plenty of investors don't want to wait; they want big payoffs in no time flat. Days like Wednesday make that possible, and they provide you a window toward a much riskier part of the investing world.

When you own large-cap stocks, it's fairly rare to see double-digit percentage moves in share prices, even on big days like yesterday. But with options, you'll often see huge gains and losses -- especially during the middle of the month, as many options approach their expiration dates.

Options: The big movers
The key to understanding why options are susceptible to big price movements lies in the combination of two of their main attributes. First, because they represent only the right to buy or sell shares at a certain price rather than purchasing outright the shares themselves, buying options is a lot cheaper than buying full shares of the underlying stock.

Second, as options approach their expiration, which for options on individual stocks occurs on the day after the third Friday of each month, their values can change quite rapidly. Using call options as an example, as long as there's a chance that a stock's price will rise above the strike price of a particular option, then that option will have some value. But when there's only a week or less left for a stock to rise, that chance may be small, and the value of the option is therefore lower than in the prior scenario.

Every once in a while, though, you get a day like Wednesday, where stocks jump quickly. That can mean big profits on particular options. For example:

Source: CBOE.

Those are the kinds of one-day profits that speculators love to see. But you can't count on cashing in on them yourself. Here's why.

You need big moves
For one thing, even close to an option's expiration, it takes a big price change for options to move like this. Before Wednesday's huge jump, most of these options were well out of the money. Without a move like the one we saw yesterday, they almost certainly would have expired worthless at the end of this week.

Moreover, notice that even for some of the options listed above, the current price of shares is still below the strike price of the option. That means that even after a huge move in those stocks, option holders will need to see prices move even higher in order to avoid a complete loss by Friday night.

Finally, keep in mind that any time a particular option blossoms, there are others that are dying on the vine -- and hanging their owners out to dry. On a big bull day like Wednesday, many owners of put options lost huge percentages of their value.

Thinking long(er)-term
It's the wild behavior that options exhibit as they get close to their expiration date that makes many option investors gravitate toward longer-term options. With options that are still four to six months or more away from expiration, the day-to-day oscillations of the market are far less important than the general trend of the underlying stock. In the case of call options, if the stock's price stays in an upward trend over a few months, then option investors can see impressive gains without needing huge, improbable price swings to realize solid returns.

In your quest to build a better investing strategy, options have their place. But don't be misled by huge returns on particular options during the week before they expire. Although you might get lucky and hit a jackpot occasionally, the risk involved means you'll more often lose your shirt.

For more on options and investing, read about:

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