Continuing the series about an options education, I received this comment:
I agree with some points and disagree with many others. As for Historical volatility and Implied volatility, the most common event is an earnings announcement for an individual stock. Historical might narrow before the event and implied will often jump just before the event. This doesn’t mean the options are mispriced. The worst beatings I’ve taken tend to be when selling high option premiums, when implied was higher than historical.
I’ve been there and done that. But this post talks only about buying options. I don’t mention selling strategies because novices are taught the ‘buy and pray’ approach. That’s the methods used by the hype artists whom I so despise. They ‘energize’ the students, and get them excited about leverage and how much can be made.
Trading is work. It can be fun, but no one should come away from lessons so energized by the thoughts of earning a quick fortune.
Those energized students go home and tell their friends about an exhilarating learning experience. Fantastic publicity. There is nothing better than an excited and eager student to tell others about the seminars. The student, who does not yet realize that he/she learned far too little to make any money, is touting the course for the hype artist teacher.
There is no incentive to present options in a true light. I try, but am not a TV talking head with a huge audience.
I would also tend to disagree packet #5. What some successful traders do is sell premium on some options and then put that money into buying OTM premium in specific instances. That goes hand in hand with packet #6. I might be tempted to start with packet #6 for novices, because risk management and right sizing of positions is probably more linked to the long term survival of novice option traders than predicting market direction, or seeking undervalued or overvalued options.
Risk and reward are often near a straight line with options. If an option position has a 80% chance of winning, there is often a 5-to-1 pay off for the opposite side that only wins 20% of the time. Not always true, but the options market is much more efficient now, than many years ago.
Agree about packet #6 and the importance of risk management. Just one minor point. I cannot teach risk management to someone before I show them what an option is and how it works. Risk management comes near the beginning of the education process. But it is not step one on day one.
When (packet #5) I said ‘do not buy OTM options,’ I was referring to not buying them as a speculative play. Beginners love to buy options and encouraged to do so. They especially grab options that cost very little cash – and they anticipate hitting a 10-bagger. That’s what the hype artists allow their novices to believe. When beginners are taught to buy OTM options and expect to beat the odds, they will blow up their accounts. It will not be a one day disaster, but a slow, steady decline until the money is gone.
I teach buying OTM options – BUT ONLY as insurance to limit losses.
Regarding the straight line payoff – I believe you are speaking to the experienced trader. The novice has no clue which options to buy. He/she does not know which options are over-priced and which are not, has no idea of how much to pay or how long to hold (all the way to expiration is the typical choice), etc. They are unaware of how changes in IV affect the price of the options they purchase. Even when the odds are reasonable (i.e., the option is priced fairly) the novice has much more to learn before placing his/her wager. And buying options is a wager (unless the trade is made as a hedge).
I’m not going to rehash the bit about technical analysis, but would suggest that all novices would do well to learn at least the basics of reading a bar and/or candlestick chart, so they can follow the commentary that typically dominates short term trading discussions. They won’t master the art any time soon. However, the basic basics can be taught in a hour or less and that is plenty for most novices to chew on. A few may take to it like ducks to water.
Regarding TA. Read a book or two? Sure. Practice making/reading basic charts? Yes. Try to recognize support and resistance to help guide trade decisions? Go for it.
However, that is very different from being encouraged to begin a trading career by reading charts as the method for knowing what’s going to happen in the market.
You are correct on every topic you mentioned. I agree with your comments. However, from my perspective those comments were removed from the context of the text, which is: “Rookies buy options. Rookies are encouraged to depend on charts. This is a bad practice. This is not a reasonable method for educating a beginner.”
Alternative strategies that offer better chances of success – that’s my approach. Offering the opinion (and evidence if needed) that it is almost impossible for the vast majority of people to predict market direction is a much saner approach. Anyone who takes the time to study technical analysis may find a talent for chart-reading. However, the more likely result is that TA is too difficult to use successfully (without a lot of experience)
Thanks for your input.