Your Opinion Sought: Is Investing With Options Suitable For the Masses?

Based on a recent conversation I had with a professional in the financial field, I'd appreciate hearing from readers concerning your opinion on the use of options.

2008 has been a bad year for almost everyone who invests in the stock market.  I'd like to know what you think about options – both based on your own experience and on your general impression about using option strategies.

Use the 'comment' tab at the bottom of this article.  Thank you.


In short, what I want to know if whether you believe options are easy or difficult to understand; whether you have profited by using them; and whether you would, or already have, recommended that others adopt options strategies.

Do you think that 'most' individual investors can understand option strategies:

a) With little effort?

b) with major effort?

c) It's just too complicated for most.

Thank you

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13 Responses to Your Opinion Sought: Is Investing With Options Suitable For the Masses?

  1. odaz6ozy 11/05/2008 at 1:18 PM #

    B.

  2. Martin 11/05/2008 at 1:41 PM #

    With respect, Mark, I think it’s much more complicated than a), b), or c).
    I expect that most equity investors could understand basic option strategies, such as buying a call rather than buying a speculative stock outright, or buying a protective put for stocks that you can’t or don’t want to sell. After the last couple of months, I hope that more people learn about the use of puts as insurance, anyway. It would be good if brokers were better educated in this themselves, so that they could at least recommend a few OTM puts to their stock-holding clients.
    However, when it comes to more complicated strategies like spreads and butterflies and calendars, or to managing the Greeks, or delta hedging, or taking advantage of IV movements, or… well, no, I really don’t think that most investors are able or willing to put in the time and effort it takes to understand all of that.
    I’m a software developer, with a reasonable (but not quant-level) background in mathematics and a pretty analytical approach to investing, and I’m finding the whole field of options fascinating but decidedly complex. Someone with a less “left-brain” orientation may be much happier, and probably better off, following Burton Malkiel’s advice and going for, say, a collection of index-tracking ETFs.
    I don’t mean to be condescending when I say this. I’ve explained various option strategies to several very intelligent and interested friends, even taken a couple of them along to the Optionetics seminars; and, while they were able to get the general idea and to see some of the advantages of trading options, only one has gone so far as to open an account and buy a simple call option. (And I believe that even she has gone back to simply trading in stock now.)
    There’s also a more philosophical issue here. If options really are fairly priced — and I’ve had former CBOE market makers tell me they’re usually pretty close — then the expected return (ignoring commissions) should be zero on average; this is the quants’ no-arbitrage principle at work. You need more of an edge than simply getting lucky, or believing in your own ability to pick direction. That edge, I’m led to believe, comes not so much in which underlying asset you choose, or which option strategy you implement, but on how you manage the trade once you’re in it. I am still trying to understand this myself, and to apply it to my own trading; but if this is so, then simply buying options rather than stock is not going to bring the results that most investors will hope for.
    So what’s the answer? Are options merely a specialized tool for the select few? In the interests of better liquidity (and people to trade against :), I hope not. I think that far more investors could take advantage of options, first, as insurance; second, through CTAs and other advisors; and third, through hedge funds and other structured products.
    The latter have gotten a bad reputation lately, and it’ll probably be a long time before the average investor trusts the stock markets again, let alone those nasty derivatives. But there’s something to be said for a fund which, say, keeps most of its assets in high-quality fixed-income investments, then uses limited-risk option strategies to provide higher returns.
    Anyway, pardon the long-winded reply, but I think the answer is really much more than a simple yes or no. Thanks for making me think a bit this morning! Cheers…

  3. Mark 11/05/2008 at 2:05 PM #

    Martin,
    Cheers to you and thanks for the thoughtful reply.
    I believe that millions of investors can profit by understanding how options work – and that the education process would not require too much effort to discourage those who want to learn. That’s why I’m seeking opinions on just how daunting readers believe ‘learning options’ is.
    I too wish that more people had been aware that a stock market portfolio could be insured by the purchase of puts or collars.
    Not condescending at all. I have an active trader friend who cannot convince his brothers or his son to be interested enough to pick up a beginner’s book. They have no interest.
    When you speak of ‘fairly priced’ options and getting an ‘edge,’ that’s more than I had in mind. I’m primarily interested in having investors understand that they can reduce risk by using options. If they accomplish that, and feel comfortable with the hedged portfolio, I’ll be pleased. Learning to be a trader requires a whole other mind-set and is really beyond the scope of what I hope to learn here.
    Yes, trade management (risk management is paramount), but again – that’s more for people looking to use options solely to earn profits, as opposed to people whose primary concern is risk reduction – with extra profits as a desirable, but secondary goal.
    Mark

  4. Simon 11/05/2008 at 4:33 PM #

    Mark,
    I’ll try and answer your questions as best I can. I never had much interest in the markets or how they worked, 2 years ago I wouldn’t have been able to tell you how one could acquire shares. I now trade them fulltime profitably!
    I have tried to explain what I do to friends and family to little avail and would recommend them to anyone who shows interest, however very few have, and those that have, haven’t stuck with it.
    This leads me to your last question “Do you think that most individual investors can understand options strategies?” I will answer this question with a scenario and leave it to you to decide.
    I am of average intelligence and never excelled in mathematics, it took months to understand basic strategies & more than a year to figure out the greeks. I stuck with it after significant losses and never gave up when I really wanted to. Why did I persevere you might ask? I guess I’m hard wired that way. Understanding options is one thing, having the right soft skills is another.

  5. dp 11/05/2008 at 5:26 PM #

    I relatively recently “discovered” options. Interestingly, I’m also a software developer and they appeal to me greatly. I’m a hyper-active and have a bad track record of being right in my stock picks/timing more often than I’m wrong, but taking profits on the winners too early and holding losers waiting for the recovery that sometimes comes and sometimes doesn’t.
    Options have been my “cure”. When I’m right the percentage gains come quickly and I’m out. When I’m wrong, a sudden 10-50% loss rather than bleeding to death 1-2% a week waiting for a recovery forces me to cut losses and move on.
    As for the original poll, I would go with (A) for basic calls/puts, (B) for everything else and (C) for people who don’t have the time or inclination to check their positions much more often than they would need to with stocks (last month of market activity notwithstanding).
    Hope this is helpful…

  6. Rik 11/05/2008 at 6:04 PM #

    Options are not an option for the masses. Not because they don’t have at least average intelligence. The problem is our society’s short attention span. The masses will not be willing to spend the time required to learn enough to be effective, and would therefore have a negative experience.
    Rik,
    I wouldn’t want to encourage investors to get involved if they are going to have negative experiences.
    Mark

  7. Brent 11/05/2008 at 6:16 PM #

    I forgot what book I read this in, but it said, “When someone says they trade options that could mean almost anything.” I do think buying puts/calls is something well within the grasp of someone who already understands stock trading basics. However, there are much more complex strategies out there but I still believe they are within the reach of anyone willing to put in the time and effort.

  8. dp 11/05/2008 at 8:17 PM #

    Simon,
    Great to read your story. I’d love to hear more about what you learned and what behaviors you changed that took you from significant losses to trading profitably full time.

  9. Peter 11/06/2008 at 12:08 AM #

    Hi Mark,
    I would like to believe that options are for everybody. My experience suggests to me that they are only for the people willing to put in the time and effort, stick with it through good and bad, and are VERY careful at managing their risk and money. For me, you only have to look at how Optionetics does their stuff – they must get thousands of people through the door for the 2 day introductory, and it seems to me like animals going to the slaughter – how many of them are left after a relatively short period of time in the market??
    Peter.

  10. Mark 11/06/2008 at 8:18 AM #

    Peter,
    You and I are on the same page.
    I believe groups that charge huge fees for 2-day seminars offer far too much material, leaving the rookie bewildered. But they offer a solution: buy more seminars!
    That’s just one additional reason why the word ‘options’ has a negative connotation.
    I prefer to help rookies truly understand what they are doing and to recognize the importance of what you call ‘being very careful managing their risk and money.’
    Mark

  11. simon 11/06/2008 at 5:04 PM #

    dp,
    My story seems to strike a cord with alot of people, more so with my close friends who never could have or would have imagined I would be doing this. If I look back at my trading behavoiur in my early ‘losses period’, when I tried to sprint when I should really have been walking very slowly it all makes sense. I had no idea about the complexities of options and was too pig headed to even try to understand them. It was’nt untill the losses realy started piling up and I thought I have just spent more than a year of my life and have nothing to show for it except the hole I had dug myself into. It was at that moment I realised I had no idea what I was doing and could’nt even fathom how I could get back from this.
    The turning point came as I decided to face the truth about my capabilities, the cons being I dont have the math smarts to crunch figures in my head or discect charts and formulas at will, nor do I have the experience or skill to understand market economics. However, what I do have is determination and tenacity to never give up.
    I had to get my head straight, so I read a book called ‘Trading in the Zone’ by douglas and the little light in my head turned on. This game is all about pyschology and positive expectancy, perfect I thought. Thats my edge! I have the mental makeup to remove emotion from a situation, have had an in built discipline all my life and a natural contolled methodical way of working through things. I began to path a road back using what comes natural to me and became passion for options along the way.
    Hope you got something from this dp, and thanks Mark for asking the question that made me think back to how it all started.

  12. dave 11/07/2008 at 12:34 PM #

    I dunced into trading options only a few months ago when writing covered calls on some core positions morphed into actively trading them through neck-snapping gyrations of the financial mkt turmoil. I saved a rather large (to me) account from an approx 30% disaster. Studying past an initial too-good-to-be-true reaction, now I understand my new found “strategy” arrived on the shoulders of a unique (and unfortunately brief) period in market history…. IV will drop… But I’m absolutely hooked!
    A> yes
    B> yes
    C> hmmmmmm, there’s a lot of lazy folks out there into instant gratification…..

  13. Mark 11/07/2008 at 12:53 PM #

    Dave,
    I agree that laziness is an unfortunate trait where options are concerned. Investors/traders who assume they ‘get it’ right away are setting themselves up for later failure.
    I like the way you adopted options out of necessity, and reaped the benefits of risk-reduction.
    I’m sure you are aware that covered calls writing is a bullish strategy, and yes, when IV drops, you are going to be much less satisfied with the premium you can collect.
    One warning: Please don’t consider selling ‘extra’ calls for the income they provide. The risk is enormous.
    Thanks for sharing.
    Mark