Attacking Advice from an Options Guru

Options for Rookies New Home Page

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

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

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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18 Responses to Attacking Advice from an Options Guru

  1. rick forno 08/27/2010 at 6:51 AM #

    Wow, Mark. This is the first time I’ve ever seen you noticeably get your dander up (such that it was) in a blog entry. Clearly this bothered you, and I agree with your sentiments and response in sifting through the marketing hype to offer reality.
    Note: I don’t know Bernie’s service, so I can’t comment on them. Clearly, complete education is required to be a successful trader, and I hope these sites offer such in-depth analysis/education.
    That said, I posit that many ‘mainstream’ options advisor sites are in the business of “selling hope” of profits to those who think trading is as simple as a “click here and profit!” type of system like you see on Saturday morning infomercials. Whether or not that applies to Bernie’s service, I can’t say, obviously.
    In their defense, though, perhaps many/some of the items you raised are discussed internally by their advisors or in their member-only newsletters — as we all know, marketing folks tend to keep things idiotically simple to get their message across to the masses.
    Speaking of advisory services / analysis, I’ve found the ‘best’ (er, most objective, rational, and likely accurate) ones are the ones who DON’T advertise like crazy and take a quiet, conservative, non-sensational, non-hyped approach to their trading efforts and public presence. They’re looking to seriously grow/manage money and not just churn through paying customers looking for hope.
    On a different note, invoking the Flash Crash as a reason to own options is akin to folks in my industry talking about sensationally spooky “Cyber Katrinas” or “Digital Pearl Harbors” to scare folks into agreeing with their statements on cybersecurity stuff. Grrr.

  2. Mark Wolfinger 08/27/2010 at 8:12 AM #

    It’s one thing to hype, sell, and over-sell whatever it is that you sell. Let the buyer beware.
    But this piece tells people to use options – albeit with only a modest portion of their investable assets (and that part really is good advice, so far as it goes)- to extract money from the market.
    He gives a bunch of different strategies, each of which works – but only when you are correct in prognosticating market direction (or lack of direction). He encourages playing the weeklys. To me, that’s gambling – not investing or trading.
    What rankles me the most? His company takes in millions of dollars annually by selling hope. Does that make me jealous? Absolutely – it does. He has a big sales team and advertising budget and it brings in people who pay significant dollars for his newsletters and suggested option plays. he gets the financial rewards. I get (and cherish) letters of appreciation from readers.
    I know his approach works. It’s big business. I’m here, trying to reach a much (much, much) smaller audience and provide quality information and education – and there is just no money in it. None. [Want to help? Simply click an ad and fill out the form. Or buy stuff from by going through my link to amazon]
    Yes, I’m jealous. But I hate that he makes his money spreading bad information. That’s the real problem. I refuse to go the ‘hype’ route. I have too much integrity and am unhappy that the rewards go to those who may do more harm than good.

  3. Marty 08/27/2010 at 9:05 AM #

    Hi Mark,
    I completely agree with you about the frustrations that come from watching shysters and snake oil salesmen ply their “trades” (pun intended). Perhaps a small number of them understand just enough about options and investing to be dangerous, and aren’t quite as guilty as the majority who must certainly realize deep down that what they’re doing is wrong.
    That said, I think there are a couple things to keep in mind that may help us all keep our sanity in the face of an unfair world:
    1) If this is truly a zero-sum game we’re involved in (I’m not entirely convinced this is true), then we depend on people making unsound or emotional trading decisions to supply any profits we end up with by choosing to avoid such methods ourselves. It’s unfortunate that the hype artists can earn a living through deceiving people, and I think you have every right to confront them about selling mis-information. In the meantime though, they’re putting money in the pockets of people who take the time to study the markets and understand reality for what it is, not just what they wish it could be. When I look at the situation that way, it seems a little more fair. (or is it “fairer”??)
    2) The world is inherently unfair and there’s not much an individual can do about it. So I’d say by spreading good ideas about risk/reward, money management, etc to even 1/10th the audience that Shaeffer Investments manages to lure in with greed-based sales pitches, you’re actually doing pretty well for just one person.
    3) Remember, most people who get sucked into scams are looking to get something for nothing. If they haven’t learned by now what an impossibility that is, it’s not anyone’s fault but there own. They need a wakeup call and losing some money will hopefully snap them out of the delusion that the markets owe them an easy living.

  4. Mark Wolfinger 08/27/2010 at 9:31 AM #

    1) I do not believe it is a zero sum game
    2) Despite the number of clients any of these gurus has, and despite the fact that their trades may be losing money (I have no proof that they do lose money) there is just so little money to be divided among all the other traders in the gigantic marketplace that I doubt you have earned even one dime of that money.
    3) It’s true that people want money with no effort.

  5. Kim 08/27/2010 at 1:59 PM #

    Needless to say that I agree with 99% of your comments. I’m not sure why Bernie Schaeffer is considered an options guru.
    According to Hulbert, his newsletter “Option Advisor Aggressive Portfolio” returned -20.0% annually since inception in 1982, compared to 10.6% return of Wilshire 5000. That’s not a typo: 20% average annual loss in 28 years!!! He was down 33% in 2009! Unbelievable!
    Actually, if he truly believes to what he is saying in his article, that’s not surprising.
    To be fair, there are few honest, transparent and fairly successful option advisory services. Bernie Schaeffer is not one of them.

  6. Mark Wolfinger 08/27/2010 at 2:07 PM #

    I had no idea his annualized return was so bad. And he charges a hefty fee for his recommendations. Thanks for the additional support for what I know to be true.

  7. 5teve 08/27/2010 at 9:33 PM #

    It is one among many very commonly sales articles from so called “option gurus” these days. I feel I am so lucky to find this blog ppl which truly care about education. Thanks Mark

  8. Jesse 08/27/2010 at 10:39 PM #

    Mark is genuinely generous in eduacating option public, he should be credited with an award!

  9. Mark Wolfinger 08/27/2010 at 11:10 PM #

    Jesse, 5teve,
    Thanks. I appreciate the comments.
    If you would like to do something in return, please click on an ad at the end of the post.

  10. Jesse 08/28/2010 at 3:39 AM #


  11. Donald W. 08/28/2010 at 1:57 PM #

    Glad you said that Mark, Nice Article.

  12. Dave 08/29/2010 at 12:07 PM #

    If my guy has 10 (or 50) times less the readership than their guy then I’m studying from the right guy!!
    Don’t worry about the money… If he dies with more of it than you– so what? In the mean time I’ll request the wife to purchase from Amazon w/ linkage from your site (she really tears it up there…)

  13. Mark Wolfinger 08/29/2010 at 12:37 PM #

    Thanks. I appreciate your using the link.
    It’s not the cash that’s so important in itself. But in this country we ‘keep score’ of many things with dollars. I believe I am writing a successful and useful blog. Readers send that message, and that is rewarding.
    But my ‘score’ is low. I guess it’s just psychological, but that feels like ‘less success’.
    Comments such as yours make me feel much better.
    Best regards,

  14. Marty 08/30/2010 at 9:13 AM #

    Have you written any articles (or can you recommend any) arguing against the zero-sum-game theory? If not, would you consider it for a future post? I’d love to hear your thoughts, especially considering your MM background.

  15. Mark Wolfinger 08/30/2010 at 9:42 AM #

    Zero sum – is to me – a matter of semantics.
    Sure it is a zero sum game when looked at from a purely mathematical perspective. But that’s not how we trade.
    If I sell a covered call, I am willing to sell my stock at the strike. Thus, if the stock moves above the strike and I sell it, I win. I collected the premium (enhancing my win) and I sold my stock. How can I do better than that – when I wanted to sell my stock?
    The Zero-Summers would claim that the option buyer won and I lost simply because I did not get the maximum value for my trade.
    To me, that argument is nonsense.

  16. Marty 08/30/2010 at 10:08 AM #

    Sure, I see what you mean. There are too many possible motives behind any trade to determine who “won” or “lost” based on the results of only that single trade. Thanks!

  17. John M. Perlette 08/30/2010 at 4:34 PM #

    Hi Mark: I just want to let you know that as an options rookie and a reader and re-reader of your book and blog, I was fully prepared to recognize Schaeffer’s emails to me as irresponsible marketing hype. Knowing your work enabled me to see through his. Thanks.
    As a fellow educator (U.Chicago Ph.D., 35 years teaching in a major U.S. University) I have to say that low cash reward just goes with the territory. But loving what you do? Well, as that credit card ad has it, priceless.
    (I use Amazon a lot. From now on I’ll access through your site.)

  18. Mark Wolfinger 08/30/2010 at 5:04 PM #

    I thank you. Priceless.
    Maybe by the time you retire, you will be a full time trader! Good trading and thanks for sharing.