It’s a Dangerous World

I stress the importance of getting a solid options education
before you begin trading. But it’s not
that easy. The world is filled with bad
advice. Each of you must decide if the
statements made by an author make sense. The following is a brief excerpt from a well-respected options
professional trader, teacher and author.


“you can play and risk very little. Options can cost as little as $5.00 to
control 100 shares of stock. And when you buy options, the most you can lose is
what you pay for the option, nothing more. Consequently,
buying options is the best way to start trading options.” (italics inserted)


It’s true that not every ‘expert’ agrees with every other
expert and there is often no single ‘best’ answer to an options trading
question.  But the author I quoted states that
buying options doesn’t have to cost much and therefore it’s the best
way to start.


I find that statement to be ludicrous and don’t mind saying
so. Just because it costs $5 doesn’t
make it a reasonable option to buy. Just
because you cannot lose more than $5 (plus commissions), that’s not a good
reason to make the trade.


Why would any investor want to begin trading options with a
high probability of losing money? Sure
it’s nice to get some hands-on trading experience – and that’s a great way to
learn. But, why begin trading by making
a trade that has a very small chance of earning money? Why buy a call option, watch the stock move
higher and not understand why the $5 option is still worth only $5. What would that teach an investor? Wouldn’t anyone prefer to begin an options-trading
career by adopting a strategy that has a much better chance of earning a
profit? I know I would.


This writer doesn’t tell his readers that when you buy an
option for $5, there’s little chance of ever making money.  Why? One
reason may be that there’s so little time remaining before the option expires
that the chance of the stock making the required move is tiny. Another reason is that the option is so far
out of the money that the stock is extremely unlikely to move far enough for
the option owner to earn a profit. I’m
not suggesting anyone sell such
options (that’s even worse than buying them because there’s too little reward
for the chance that something unusual happens), but I would never recommend
buying them.


This author goes on to say:


entering spreads or option writing.”


Spreads are a method for reducing the risk of trading
options and are resoundingly recommended by me. Of the six
I recommend for option traders (including rookies), four of them
are spread positions and one is similar to a spread because it’s a hedged,
risk-reducing strategy. And that one is
the option writing that this author tells novices to avoid. Let me be clear on this point: In my opinion,
writing covered calls is a better strategy than simply buying and holding
individual stocks and I strongly recommend it as a good method for learning how
options work. But, there are better,
safer strategies you can use – after you understand how options work. I suggest
writing covered calls as your entry point into the options universe, but once
you understand what you are doing, it’s best to move on to another of my six
recommended strategies.


This author then offers this advice:


by taking some very small positions”


And I completely agree with that statement.


I sincerely hope you find my writings to be helpful,
well-reasoned and that they help you earn lots of money – and at the same time,
reduce the risk of investing in the stock market.


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