Attacking Advice from an Options Guru

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Bernie Schaeffer, from Schaeffer's Investment Research, long-time options analyst and trader offers his comments on why an investor should be trading options in today's market.

After reading the piece (quoted below), I tried to communicate with him via his website. I wrote that I was going to offer contrary opinions and asked if he wanted to discuss the issues.  I received no response.

I've inserted my comments amidst his advice.  In my opinion, the suggestions offered represent the worst possible advice one can offer to an options trader.  Especially when it's intended for a general audience.

In my opinion, it imposes the wrong mindset (making profits is easy, picking market direction is easy, trading options is a simple game), giving those who follow the guru little chance of learning to use options profitably.

Yes, that's a very strong statement.  I believe options education must include information that gives the reader a reasonable chance to earn money.  But no one hands that cash to you.  It requires discipline, practice, and understanding what you are doing when making a trade.

When you teach a beginner to buy options and predict direction, you set him/her on a path of financial ruin.  The shameful part is that there's no warning of how difficult it is to earn money via this strategy.  All our guru talks about is high leverage and the possibility of making big profits. There's no mention of the odds of succeeding.

When we consider that traders who follow these suggestions probably lack much (if any) experience managing risk, it's a recipe for disaster  The only redeeming virtue in this article is the recommendation to use only a modest portion your trading account.

I have no idea of why Schaeffer's Investment Research believes that most traders can successfully predict market direction when the evidence is clear that professional money managers cannot do it (most mutual funds underperform their benchmark indexes).  If this advice is not intended for the masses, but is specifically for people with a proven track record of beating the market, then I can forgive the advice.  But when it is general advice offered to the masses, I must fight back.  I know his readership is at least 10 (if not 50) times larger than mine, but I'm not willing to let his advice go without making an attempt to salvage the situation.


The article:

"The stock market gets no respect these days.

On July 27, an article entitled "Ten Stock Market Myths That Just Won't Die" was featured in The Wall Street Journal.
It attempted to debunk just about every reason your broker has ever
given you for investing in stocks – from "investing in the stock market
lets you participate in the growth of the economy," to "the market is
really cheap right now," to "stocks outperform over the long term."
Overall, it adopted a very cynical, negative view of the market."

As well it should be.  Too many brokers and other financial professionals are out to earn commissions, not to serve customers.  Warnings are necessary.

"If this article, which ends with the comment "In the long run, we are
all dead," is your idea of helpful investment advice, then please read
no further. But at the same time, if you're expecting me to try to
"debunk the debunker" by giving you 10 reasons to be bullish on the
market, then I have a surprise for you. While I do feel that the
unprecedented rush to the exits by individual investors and the
extremely negative press that has dogged this market since early 2009
will ultimately prove to be very effective contrarian indicators, I
understand the frustrations investors feel with the post-"flash crash"
market in all its high-volatility, directionless glory.

Instead, my message to you is about avoiding these stock market
frustrations and actually setting yourself up to make some money. I'm
sure you understand this will not happen by you sitting in cash vehicles
that guarantee you safety but pay you no return. You are being
"rewarded" for the risk you are taking, and that reward is zero. But at
the same time I'm not suggesting that your only alternative is putting
your money in the market. What I'm in fact suggesting is that you commit
a relatively modest portion of your capital to STRATEGIES designed to
EXTRACT MONEY from the market, regardless of direction, or even if there
is NO direction. And the only investment vehicle that can accomplish
this for you is options."

Committing only a modest amount of money makes sense.  I can agree with that.

Adopting strategies that are designed to extract money from the market also makes sense.  However, isn't that the purpose of every strategy? 

The difficult part is knowing which strategies to adopt and when to use them.

"So in the format of the aforementioned Wall Street Journal
article, but with the goal of providing you with actionable information
designed to grow your portfolio, allow me to list for you 10 reasons why
you should be trading options right here and now.


  • The calls in your options portfolio will allow you to
    achieve big leveraged gains if the market catches most investors by
    surprise and rallies through year-end"

That's true.  But the bigger truth is that you can readily lose 100% of the capital
invested.  Bernie, I admire the fact that you caution investors to use
only a 'modest portion' of their portfolio for these plays, but they are still high risk plays that require accurate market prognostication.

"The puts in your options portfolio will protect you against
"flash crashes" and other disruptive market events and even allow you to
profit in these situations." 

This is also true.  Are you suggesting that buying both puts and calls gives your investor a good strategy for extracting money from the stock market?  I believe it's far more likely to extract money from his/her investment account.

As the 'flash crash' made obvious, it's not easy to get orders entered, and even more difficult to get them filled, during such an event.

My conclusion is that another flash crash is unlikely, and preparing for it is a waste of time and money.  Preparing for a true market debacle is another story, and being certain your portfolio is not decimated when that happens – makes sense.

  • "You can still benefit from the unlimited profit potential of option buying yet limit your loss from any trade to 20-30%."

Limit losses?  Are you suggesting that option buyers unload their positions when losses reach that 20 to 30% limit?  That hardly gives them a chance to profit if that 'big rally' doesn't begin pretty soon. Limiting losses is a fundamental aspect when trading, but not for the scenario you described.  You want them to be involved if there is a rally through the end of the year, but you don't want them to own positions when losses exceed a designated limit.  Those are conflicting goals.

  • "You can profit from market volatility regardless of the direction of the price movement."

You can lose from market stagnation, or reduced volatility – regardless of direction.

  • "You can profit from buying calls on stocks that outperform,
    and at the same time buying puts on stocks that underperform their
    industry peers. That's the easy part." 

We all know how easy it is to pick which stocks will outperform.  The proof is in the fact that each of your clients has already achieved multi-millionaire status and is heading towards the billionaire level. 

And your newsletter must be at least 95% accurate when picking direction.  It's a cinch to do this. Just look at all the mutual funds – who pay big salaries for management personnel, and their track records. 

Hmmm…I must be missing something here.  Those managers tend to underperform.  But that's okay, I'm sure your customers are much better at picking direction than all those pros.


  • "You can achieve huge leveraged gains by buying options during
    expiration week, when premiums are extremely low. And now, with the new
    Weekly Options, there is an expiration week every week."

Wow.  Yes indeed.  Good thing you are so good at picking direction because the nay-sayers would tell you that's it's a great opportunity to lose 100% of your money in a hurry.

Did you know that the 'extremely low' option prices are accompanied by exceptionally rapid time decay?  I suspect you did know this, but chose not to mention it.

Buying Weeklys?  Leveraged profits are nice.  What about 100% losses?  Or do you stop yourself out of these trades after 2 days?

  • "You can profit from the strong tendency of the market to
    trade in well-defined ranges most of the time with a carefully selected
    option premium selling program." 

Well, which is it?  Are we to buy or sell these options?  You must tell us now, before we actually go out and make the trades suggested earlier. 

Or is this this another example of making option trades when we know how each stock is going to perform?

  • "You can profit from the huge volatility around events like quarterly earnings reports."

And do we do that by buying or selling the 'huge volatility' displayed prior to a news announcement?


  • "You can profit by buying call options on stocks that are in
    long-term uptrends, at much lower dollar risk than buying the stock."

Agree.  I hope you are referring to ITM options, and not suggesting that traders buy OTM, or even ATM options.  I assume that your readers are good at judging which stocks are in firm uptrends.

  • "You can profit in all market environments by trading multiple
    option strategies on highly liquid exchange-traded funds on
    broad-market indexes, like the QQQQ."

Okay, but you wanted investors to buy calls on the good stocks and puts on the decliners.  How does trading an ETF allow for that?  Now they must predict market direction for the whole market, rather than for individual stocks.  So, does that mean all the advice given above is no longer valid?

  • "In the long run we may all be dead, but we can make the most of the
    short run by looking to the options market for our trading
    opportunities."


Yes Bernie, all those opportunities are present.  But how do your readers know when to buy (or sell) puts or calls?  You neglect that one little detail.  Or are they supposed to buy your costly newsletters to get the answers?  

In my opinion, options are designed to reduce risk.  Neither buying options nor selling naked options is the investing method that gives trades the best chance of success.  A jackpot possibility – yes, it provides that.  But that's no different from gambling and I'm disappointed that you shared these inconsistent thoughts with the world.

  • "A good place for you to start might be our Options Center,
    where every trading day we slice and dice what's happening in the
    options market and its implications and where you can also find a wealth
    of options-based tools and filters and explanations of various options
    strategies."

I truthfully don't know how good this information is.  But, it may probably worth a look. 

Bottom line: This is the type of guru advice offered to the average options trader.  This is the type of advice that gives options and options trading a bad name.  If you want to gamble, follow the advice offered by our guru.  If you want to use options with the chances of making a profit on your side, then understand how options work, make good trades, and carefully manage risk.

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