My Philosophy on Options Education

Education: An activity that imparts knowledge or skill.

When I work with individual investors or write blog posts and books, my objective is for the reader to learn something he/she does not already know.  That includes providing enough details that the clouds disappear and the reader gains a better understanding of the topic under discussion.  

Careful and detailed explanations take time to explain.  If you require instant gratification and the ability to attend one webinar or lesson and then immediately begin trading, I cannot help you.

Details?  What does that mean? I stress the details that help you reach a better understanding of the lesson material.   Unless the topic is risk management (and that's a big topic) there is no reason to bother with details of events that are extremely unlikely to occur.  My job is for you to come away from a lesson with something of value for your trading career.  And that's true for the trader who devotes only two hours per month to his/her investments as well as the full time trader.

There are trading tidbits that you will accumulate and points of view that you, the trader, will develop over the years.  Rather than wait for traders to slowly gather insights on certain more advanced topics, I prefer to see that you get an inkling of the importance of certain features of options – even when it may be soon soon for some students. 

One example is the idea that two very different-looking positions can be equivalent, i.e., they produce identical profits and losses under all market scenarios. Most beginners don't get introduced to that concept until they are well into their trading.  I believe this idea is so important to an understanding of how options work that I introduce it early.  If anyone does not see the importance, or does not yet understand how equivalency works, no harm done.  The idea has been mentioned and soon enough, as specific trade ideas are introduced, the 'eureka' moment arrives and the concept becomes clear.  Accelerating the date of that moment makes better traders of those in the class.

We all wish we had understood something more clearly, or recognized the true risk of an innocent-looking position earlier in our trading careers.  For example, I believe the successful trader must concentrate on risk as his/her primary focus.  Many others prefer to concentrate on profit and loss, and do anything in an attempt to achieve that profit.  That is dangerous for reasons that may not be obvious.

When you grasp the 'little extra stuff' early in your career, it often makes a big difference in whether you succeed or ultimately give up the game.  The very first rule to understand is: Don't go broke.  It seems obvious, but it's something ignored by too many traders – until it's too late. I help traders learn how to minimize the chances of going broke.  It's not as simple as: "Don't take a lot f risk in one trade."  Some traders lose their accounts slowly and end up just as broke as the person who blew up over a single trade.

When I clarify some previous misconception held by a student, that is truly hitting the jackpot (for me).  Trading is a business that punishes mistakes.  Everyone tells us that we learn from our mistakes.  That's true ONLY when the mistake is recognized. If a trader repeatedly acts on a misconception, those mistakes are difficult to discover – and hence, are going to be repeated.

I love the breakthrough when something under discussion results in an 'aha moment' for the student.  As a writer, I never know when that happens, unless you let me know.

So what do I mean by that introductory statement – to teach something you don't already know?  Here are some examples that appear frequently in my writings:

  • Explaining something from a different perspective
  • Including extra details, just in case they can provide a better understanding
  • Including information to answer questions before they are asked
  • Explaining the rationale behind my opinions. 'Why I believe it's true'
  • Outlining a philosophy based on common sense, and not on traditional rules
  • Being willing to take a minority stance – but always telling readers when most others have a different point of view
  • Encouraging readers to think for themselves before making decisions
  • Continuously stressing the importance of risk management
  • Explaining that choosing a good trading strategy is just the beginning
  • Why trading near-term (front-month) options is more risky that it appears
  • Why it's easier to make money by selling, and not buying, option premium
  • Why selling naked short options is too risky for most traders (unless you sell puts with the intention of owning stock)
  • Sharing the opinions of other option writers and bloggers


One on one

When working with a trader one on one, my philosophy is to help with specific topics of interest to that student.

I don't have 'lessons' prepared in advance. I don't have any specific number of lessons planned.  These sessions are designed to answer your specific needs.

Risk Management

Concerned with capital preservation?  At Options for Rookies we live and breathe risk management.  I stress the importance of controlling risk from the very beginning of your trading education.  This is not a topic suitable for experienced traders only. Why?

If you trade without measuring and controlling risk, the risk of ruin is too high. Don't count on a lengthy trading career when being aware of, and respecting, risk is not at the top of your priority list.

When dealing with the stock market in any capacity, you are dealing with statistics.  You must be alert for unlikely events.  By being aware of the probabilities of winning and losing, you can trade only when the reward justifies the risk. 

You will have many winning trades by doing just that.  However, long shots have their day and black swan (unexpected) events do occur.  Your task as a trader (and mine as a teacher) is to see that you are prepared for the unlikely event. 

As a premium seller, gigantic market moves represent the enemy.  Portfolios can be protected against disaster, if you are willing to pay the price of insurance.  One alternative is to be very careful when sizing trades.  Be aware of the worst case and you can limit losses to an acceptable amount.

It's all part of risk management.

 

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11 Responses to My Philosophy on Options Education

  1. rluser 01/28/2011 at 8:47 AM #

    Wow! The new look is quite a surprise (even though you told us). So far I like it, but I haven’t found the comments.

  2. Mark D Wolfinger 01/28/2011 at 8:59 AM #

    Having more problems than anticipated. I apparently made a big error.
    The comments are here, but may not be reachable at the moment.

    Please standby.

    Thanks

  3. Mauro 01/28/2011 at 10:06 AM #

    Hallo,

    I’m glad you mentioned the fact that two different option positions can be the same. But i don’t see the similarity between a covered call and a short put. Especially when you receive a dividend in that periode of time.

    Lets put some numbers in the B & S formula:
    – Strike 100
    – Stock price 100
    – Volaltility 25%
    – Duration 30 days
    – Interest 0%
    – Dividend 2%

    => The theoretical price of the call is 2.78 and the put is 2.94. I understand that the reason why the call is cheaper is because there is a dividend, but the price difference is very small.
    If we calculate everything, we get this result:
    * Stock + written call + dividend = 100 + 2.78 + 2 => maximum profit 2.78 + 2 = 4.78
    * Written put => maximum profit= 2.94

    It seems that the covered call performe better. Of cours we could argue that the stock price will decline when the dividend has been paid. This is true, but in most cases we see the stock rise again the next days. So the the dividend won’t harm the stock price that much.

    Thanks

    • Mark D Wolfinger 01/28/2011 at 10:46 AM #

      Mauro,

      Thanks for the good question

      1) the stock price does NOT ‘IN MOST CASES” rise again in a few days. If it did, everyone in the world would buy stock ahead of the dividend.

      2) Your calculations are not accurate. I note that you set interest to zero and thus, it has no effect of this example. In the real world, interest is not zero and it costs cash (thus, interest) to buy stock and sell the calls. That cost of carrying the position to expiration must be subtracted from the profit calculation for the covered call.

      3) If the stock is 100 now and is going to pay the dividend, then the stock is ‘really’ $98. In other words, once the dividend is paid, the stock will be trading $2 lower. It’s not reasonable to assume the stock will rise by 2 points.

      4) Most importantly, you have the incorrect theoretical values.

      Using your parameters, plus a volatility of 32%, my calculator shows that the call is worth $2.74 and that the put is worth $4.71. This agrees with the idea that the stock really is $2 lower.

      These are equivalent positions.

      Regards

  4. Sal 01/28/2011 at 11:02 AM #

    Mark, I like the new look!

    The only thing at the moment I’m confused about is Roll Over or Roll out. Are you saying when you close out a contract to roll it over to the following month, you do it after a small increase in the price of the underlying stock? Can you make a decent living doing this? But I’m confused as to where the profits come in.

    Thanks

    • Mark D Wolfinger 01/28/2011 at 11:10 AM #

      Hi Sal,

      No. I did not say that.

      1) I am not a big fan of rolling positions. However if you choose to roll – then do it ONLY when you want to exit the original trade (or are forced to do so because expiration has arrived) AND you want to own the new (i.e.e, after rolling) position.

      2) No. There is no need roll after a small increase in the sock price. Of course you did not mention the strategy you are discussing, but rolling so quickly does not make sense. It leads to over-trading, high commission costs, and lost of cash lost to slippage (bid/ask differential)

      If you have a covered call, the price increase is good news. No need to even think about rolling.

      If you sold a call spread, I must assume that a small move is not enough to cause any problems.

      3) I’d love to tell you where the profits come from. Please let me know which strategy you are asking about – then I’ll reply further.

      Thanks

      • Sal 01/28/2011 at 11:25 AM #

        Thanks for the fast response. I was talking about closing my covered call position that I’m currently holding. I hope this clarifies,

        • Mark D Wolfinger 01/28/2011 at 11:37 AM #

          That makes it clear.

          When the stock rallies, you make money from a covered call position. And you do not have to hold all the way to expiration.

          a) When the stock is sold, you earn a profit (yous aid stock price is now higher)

          b) When you buy back the call, you may have a profit or a loss, depending on several factors, the most important of which is how much time has passed since you sold the call.

          If you do have to pay more for the call than your original selling price, the loss on the option is going to be LESS than the profit from the stock. That leaves you with a net gain.

          If you have a profit on the option, then you have two profits to combine.

          You can earn money doing this. However, you cannot exit the trade after a small price increase. You need a bigger increase or more time to pass. The profit comes from time decay and a decrease in the value of the option sold.

          This is not all that different from the investor who buys stocks. If your stocks fare badly, you cannot make any money, let alone a living. If you pick stocks that don’t fall, you well do very well.

          Just keep in mind that picking winning stocks (or at least stocks that don’t decline) is a difficult game for most people.

          If you want to make a decent living, you have to have some cash. If you earn 20% per year – and that’s a nice return – it’s only $20,000 per $100,000. Thus, if you want to write covered calls for a living, you must have some money to invest.

          • Sal 01/28/2011 at 11:50 AM #

            Thanks very much for clearing that up! I think I got it now.

  5. aarkaay 01/30/2011 at 12:45 AM #

    I have been buying put options on the gold for last one year, thinking that the price of gold has gone up too high too fast, and i have been loosing on all my options as all expired worthless.

    Any suggestion please.

    • Mark D Wolfinger 01/30/2011 at 7:54 AM #

      RK,
      When speculating, rather than investing, you must accept the fact that it is easy to be wrong on your expectations. Sadly that’s what happened to you. There’s nothing to be done about the money already lost. The big decision for you now is: how do you use options today and in the months ahead.

      If you truly believe gold will decline; if you want to bet real money on your beliefs; if you can afford the losses, then it’s appropriate to take a short position in gold. If EACH of those three items is no longer true, then it’s time to stop playing this expensive game.

      There is an alternative. Try a different strategy. By selling out of the money call spreads, you can earn a limited profit when gold does not decline. All you need is for it to not rise to far. The advantage of this play is that you are FAR MORE LIKELY to win the bet. The two disadvantages are that you must be careful to monitor possible losses and not allow them to get too large. The other is the aforementioned limited gains.

      Buying options is usually a losing game. Too much must go right for you to collect. I understand the possibility of making a killing does exist, but the odds of making any money are not on your side.

      If none of this is appealing, you are allowed to stop betting on the price of gold.

      Good trading