You’re not using options? Are you kidding?

Options may be my favorite investment tool, and I assume that it’s near the top of your list also, or you would not be reading this options blog.

Yet, it is an unmentionable to the majority of people who invest their money in the stock markets of the world. It’s worth understanding how this came to be, but the most significant factor (in my opinion) is that it’s much easier for brokers to push front-end loaded mutual funds, along with their high commissions, to their uneducated clients than it would be for them to learn how options work.

They push the fund and their employers are happy (especially when it’s the firm’s funds that are being sold). If the client loses money, there is no danger that the client may try to blame the broker. The fact that the client is paying high commissions and high management fees is immaterial to everyone except for the customer. If the client were smart enough to buy index funds, that client would have no need for a broker.

Why use options

Trying to explain the benefits of adopting options strategies as part of any investment portfolio in a single sentence is well nigh impossible. However, this is my standard line:

    Options can be used to provide the investor with a higher probability of earning a profit at the same time that losses can be reduced or limited.

    More frequent profits. Less frequent losses. Smaller losses. What’s the downside: Most of the time the benefits only come when accepting limited profits.

    That’s why options trading is not for everyone. But I would be happy to wager than many millions of small investors would be very pleased with the results that come when trading options with conservative strategies – but there is just no one who is going to introduce them to the idea. Sure, some other option bloggers and I tell the story of options, but the person who had heard bad things about options or who believes the absurd stories that options are only for gamblers – that person is not going to find or read any of that material.

    Nevertheless, I believe it’s right to ask the question: If you are not using options, or have not thought about using options to reduce investment risk, why not? I know you love your bull-market profits, but don’t you hate your bear-market losses even more? Did you know that you can limit such losses (just as you limit losses by setting the deductible in an insurance policy) if you are willing to limit gains during bull markets? You can do just that. And you may elect to use that methodology for a portion of your holdings.

    If you never heard of this idea, you should be screaming at your broker for keeping such secrets from you.

    In a series of blog posts, I plan to speak to the investor who always takes big risk (without recognizing that fact), but who would prefer to own a much less risky investment portfolio. I’m speaking to each investor who is saving for retirement or for the purchase of a home, or any other major life expense (college?). I’m also speaking to the very wealthy who hire investment advisors who have no clue how to manage risk. Sure they diversify and allocate assets according to some ancient rules. However, to have true portfolio protection, it’s so much more effective to use options.

    Stay tuned.

    I believe it’s obvious. Nevertheless, please understand that nothing in this post should be taken as a recommendation to adopt this, or any other option strategy. I am presenting my opinion because it may prove to be helpful when it comes to using options. The final decisions are yours alone. Do not thank me for profits earned nor blame me for money lost.

    946

One Response to You’re not using options? Are you kidding?

  1. DB 04/22/2011 at 9:04 AM #

    Hi Mark,

    Wondering if you could explain my Apr contract on GLD, I was short -145Call & +155Call.
    I noticed GLD closed at 145.05 on Friday Apr 15, but when I checked my account on Monday, they were all Expired & Closed (Ep.C). Thought being ITM by 0.01 $ would be be auto exercised, and incur some losses.

    Thank you for your help.
    (I asking my broker too, maybe I did not see they already deduct some losses)

    DB