Q & A. Trading options: Is it worth the effort?

Mark,

I wonder how many others have similar thoughts. 

As I've spent the many years trying to pick the stocks (I'm part of the 70% 'they' say who don't even beat the market), I settled on the indexes because if I have N stocks I'm
considering, chances are, and I've proven it, that I'll pick the one(s)
that under-perform slightly to significantly.  Or, as has happened
often, I picked a good one, but it hit a protective stop,
which became the near-term low. 

By doing indexes, the risk is spread and odds are better to
gain (theoretically).  You have to have such a watchful eye on what's
happening, anyway, and you can only make it green if you happen to be
on the right side of the trend.

Don,

You have concluded that passive investing beats active investing, a conclusion reached by many.  Professional advisors and planners, along with financial bloggers are pretty much in agreement that the vast majority of investors cannot beat the market by picking stocks.

Short-term traders, especially system traders disagree and feel they do beat the market.  But they are not investors.

Not everyone sees that he/she cannot out-perform the averages and many will never cease trying.  Be thankful you reached this first stage.


So far, in my elementary learning of options, it seems that you have to be on the right side of the trend to consistently
make money.  On a simple example, buy stock,
immediately write a covered call and buy a put.  If you do it right
away, chances are your return is near zero due to costs.  But, if you
buy the stock and it goes up, using the collar gives you a locked in
protection.  But, if you're locking it in, why not just sell the stock
in the first place and avoid the hassle?

When opening a collar position, you allow for a small loss and some profit potential.  You do not 'lock it in.'  Yes, you must be on the right side to profit.  Collars are insurance to limit losses.  But you don't profit when the stock or index falls and you own a collar position.

To profit from a market decline, you must be short, not long.

In a fantasy world, you'd easily be able to find situations that allow you to apply a strategy, knowing you have a locked in
6%/month, say, and not have to spend so much time on research, stealing
it from family and life in general.  Sure, everything takes work, and
maybe there's not an easier way, but by trying to learn more about
options strategies (which inherently offer protection and reduce risk),
will that knowledge/understanding of them prove useful or just a
further stealer of our limited time with no real added benefit?  If
there's no real added benefit, then it continues to become fulfilling
of Nicolas Darvas' book title: "Wall Street: The Other Las Vegas" and
you're lucky if your capital appreciates.

OK Don, now we're into the big stuff.

1) 6% per month is more than fantasyland. In the real world that is a 100% annualized return.

Fantasyland

2) Options don't provide 'a benefit' just because you use options as an investment tool.  Options do one thing very well – and that's to allow you to measure and control the risk of any investment. 

'Options' don't make money.  The option strategy you choose doesn't make money for you.

You earn money by doing a good job of risk management.  The Greeks allow the quantification of risk. Once you understand how much risk there is in your position, you can modify it (or not).  If you control risk well, you will never take a big loss and you should prosper as time passes.

The strategy is merely choosing the specific options to buy and sell.  We all have strategies that suit us because they fit right into our comfort zones.  But, it's not the strategy per se that makes money.  It' how well you manage the position.

Thus, if you do no work and expect that merely using options will save the day, then yes, it will be a time stealer.  If you are diligent, truly understand what you are trading and what must happen for you to achieve a profit from a trade, and understand what can go wrong (and how much you can lose) – then – and only then will using options prove to be a benefit. 

Or you can ignore all that and just hope to be lucky. That seems foolish, doesn't it?

 

Regards,

Don

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6 Responses to Q & A. Trading options: Is it worth the effort?

  1. Dave 09/25/2009 at 10:47 AM #

    re “stealing it from family and life…” That is the exact benefit trading options has had for me; returning some important time to where it belongs (many thanks to Mark).
    OT: This morning as I gazed lovingly into my market directional crystal ball it presented an interesting thesis– if Obama, GS & Co have the horsepower to jam this market to these levels (done– filed under proof in the pudding) then why-o-why wouldn’t they just keep it here at cruising altitude? At least until certain items on the agenda (read healthcare) have been handled? (As I write this 1000 tick cannons explode just in the knick of time, gee what a “coincidence”).
    Sorry for the guess– I know you frown heavily on that– but seems like a pretty good time to sell volatility (would be my guess).

  2. Mark Wolfinger 09/25/2009 at 12:04 PM #

    Dave,
    Trading options makes things easier because risk in under control. But it still requires time and effort.
    From your perspective (and mine) options trading does give you more time to do other things.
    From Don’s pespective, he’w wondering if it’s worth the time to educate himself. The real answer depends on how he uses options once he understand how tehy work. No one can provide that answer in advance.
    There are scammers everywhere, selling idea that are known to be worthless. Options education is not anything similar to worthless. If you take the time to figure out just how options work and how to use them efficiently – you must then put that knowledge to work. It’s not magic. No one hands you the money. I believe the education is very valuable. That’s why I am so passionate about helping people to learn about options. But I am not sitting at anyone’s computer and they must make the trades and manage risk for themselves.

  3. Dave 09/25/2009 at 2:51 PM #

    Options help me lose less money. Worrying about how much I might lose has been much kinder to my account than worrying about how much I might make.
    🙂
    Once I got over the (mostly self impoised) hump and spent some effort understanding the greeks I truly wanted to kick myself for not doing it sooner…

  4. Mark Wolfinger 09/25/2009 at 3:20 PM #

    Losing less is good.
    Making more is better.
    Being concerned with losses and doing what you can to minimize them – that’s riks management. Glad you can see how impotant that is.
    Many lessons cannot be taught. They must be self-learned. For you, using the Greeks to measure and manage risk was one of those.

  5. Don 09/27/2009 at 2:24 PM #

    Hi, Mark. Fantasyland ;-). I actually meant 6%/qtr as an off-the-cuff amount thinking about 2%/mo, but even that is about 25%/yr and if there was a way to do that and everyone caught on, it wouldn’t work anymore, would it? Anyway, I understand what you mean about options not making you money. I had in my mind the time premium you get by writing covered calls, for instance, as the way they would generate income for you.
    I saw a situation last week on one of the leveraged ETFs that after fees, if you bought the ETF, sold a covered call, bought an OTM put, it would have given about a 2.1% return for the next 2 months, whether the ETF was called away or went below the put that would require you to exercise. On the surface, doesn’t this appear to be a kind of position that would be desirable? 2% six times per year?
    Anyway, I recognize learning risk management is huge. Since it’s impossible to pick winners 100% of the time, I understand the need for capital preservation when needed and taking advantage of something at the right time, all of which risk management would help.
    I don’t question whether taking the time to learn this is worthwhile. On the contrary, to neglect learning is to continue being ignorant. I want to better understand how to control that risk. I don’t want to be in the position any more of owning a stock and having a stop loss order setup on it only to see it gap way down below the stop loss and lose all that ground that a put, for instance, would have protected you on. Or having the stop loss trigger, then having the stock take off without you because you didn’t buy it back later. Therefore, I’ll be checking out your sections on the greeks.
    Eventually, after learning these, it seems like it would be ideal to narrow the focus to what really works. A gambler doesn’t need to visit all the games in the casino; if they have something that suits them, accomplishes their goals and they can be consistent with it, wouldn’t that be a desirable place to be? You don’t need to trade on every stock all the time or find the next 10-bagger for next year (a lottery pick, if you know what I mean).
    Thanks for the tutelage so far.

  6. Mark Wolfinger 09/27/2009 at 3:06 PM #

    1) Amazingly, it would work. There are many people who would say – if you can make 2%, I can make 4%. And they would make the attempt.
    In investing, there is no ‘everyone.’ Just too many people with too many ideas. And that’s what makes the markets work.
    2)Yes, with covered alls, you are GUARANTEED to earn that time premium. But it’s not free. You must sacrifice a possible large upside, or incur a loss with a large decline.
    3) 2% 6 times per year is a very good return. But, when it comes to investing, some would not be willing to accept that? Would you still get that return if the ETF were unchanged?
    Commissions may be small these days, but collars require lots of trading. If you are sophisticated enough to understand what I mean (and if not, then this is for those who are), you can save on commissions by selling the appropriate put spread to own the equivalent position.
    If this 2+% return was really there, the only question for you is: is it usually there and can you count on it?
    4)Not in agreement with matter of ignorance. I’m willing to NOT learn how to do certain things. I see no benefit to becoming educated in those areas becuase there is so much to do in this world, and I don’t believe I can do it all. Nor do I try. Ignoring options is ok, but not when you take investing seriously.
    5) About selling on a stop-loss or similar. Not all decions are going to be winners. If you are upset about losing stock on a gap down, don’t you have success stories of big savings by getting stopped out? If NOT – that’s a serious problem and you must reconsider using those stops. Overall, is this a good idea for you? I don’t need the answer, but you do.
    6) I do know what you mean. I trade within my comfort sone and know that I mighe be able to eke out better results by modiication of methods. But if ‘eke’ is the word, I don’t care. I must be careful not to be blind to real improvements that make a significant difference.
    You are welcome. Get your friends interested in visiting the blog.