Energy stock options may sound attractive, but they’re some of the fastest ways you can part with your money.

Many aggressive investors find the lure of energy stock options hard to resist—after all, you can make a lot of money with only a small investment. However, despite their appeal, the vast majority of investors lose money with energy stock options.

An option is a contract between a buyer and a seller, based on an underlying security, usually a stock. The buyer pays the seller a fee, or premium, for certain rights to the stock. In exchange for the premium, the seller assumes certain obligations. Options trade through stock exchanges, with prices quoted each day in the financial section of newspapers. Each options contract is for 100 shares of stock. So one contract quoted at $5 will cost you $500 (before commissions).

Each contract has a limited life span, or time to expiry—usually less than nine months. The expiry date is the date on which the contract expires. The strike, or exercise price, is the price at which the rights granted to the buyer can be exercised. There are two types of options:

Calls give the holder or buyer the right to buy the underlying security at a specified strike price until the expiration date. The seller of the call has the obligation to sell or deliver the underlying security at the strike price until the expiry date, if the option holder exercises the option.

Puts grant the holder or buyer the right to sell the underlying security at the strike price until the expiry date. In turn, the seller or writer of the put has the obligation to buy or take delivery of the underlying security until expiration, if the option holder exercises the option.

Energy stock option investing generates a lot of brokerage commissions, and many young, aggressive brokers specialize in it for that reason. But many of these stock option investing brokers drop out of the investment business or choose another specialty. That’s because it’s impossible to build a lasting clientele when you place your clients in investments in which they are almost certain to lose money.

We think you should skip energy stock options all together and look for strong energy companies to invest in. As part of that advice, we recommend that most investors maintain some exposure to the Resources sector—and energy stocks—as part of a well-balanced portfolio.

The direction of energy prices depends on a lot of things, particularly economic growth rates around the world. Meanwhile, though, well-established companies in the energy industry can take advantage of the setback to pick up properties and employees who might be harder to find in more prosperous times.

Most investors who are looking at investing in energy would likely think of oil and gas first. But energy stocks also include green energy: power from renewable resources like solar power, wind power, geothermal power, generating electricity from ocean waves, plus nuclear power.

Here are nine tips for investing in energy stocks:

1. Look for oil and gas exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of additional wells.
2. Look at the market cap of oil and gas exploration companies versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings. We like an oil and gas exploration company’s market cap to be no more than half the value of the oil and gas in the ground.
3. Invest in oil and gas energy stocks that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
4. Invest in oil and gas energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.
5. Junior energy stocks are risky to invest in. But they aren’t as risky as energy stock options. Junior energy stocks can be risky because it’s relatively cheap and easy to launch a penny oil or other energy stock and sell stock to the public. So the junior energy promotion business attracts more than its share of unscrupulous operators and stock promoters.
6. Stay away from junior energy stocks operating in insecure and politically unstable regions like the Congo and Venezuela, or in countries with little respect for property rights and the rule of law, like Russia or Mongolia. Resource extraction is inherently a politically vulnerable business; you can’t move the oil wells to another country, and local citizens sometimes believe that a foreign resource company is robbing them of their birthright, even though they need the foreign company’s capital and expertise to get any value out of the ground.
7. Invest in junior energy shares that operate in an area with geology that is similar to that of nearby producers. Look for favourable factors, like attractive geology, not hostile environments, like the high Arctic.
8. Invest in well-financed juniors with no immediate need to sell shares at low prices, since that would dilute existing investors’ interests. The best juniors have a major partner who has agreed to pay for the drilling or other exploration or development, in exchange for an interest in the property.
9. Invest in juniors with strong balance sheets and low debt and positive cash flow, preferably even when commodity prices are low. Even better, we like to see junior energy stocks that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of another prospect.

Have you invested in energy stock options in the past? Have they been profitable for you? Share your insights and experiences with us in the comments.