Fake Names for Options Trading … a Vacation Special
August 21st, 2008 by StockGumshoeChange the text size:
OK, so the vacation rerun pile is getting a little thin here … thought you might be interested in seeing all of the many ads that have been sent in the past year promising that you can get cash payouts that are better than dividends, and easy as pie.
These ads all tout one version or another of an options trading strategy … for your reading pleasure.
California Overnight Dividends
Secretive Price Fixing Ring Snatches Cash
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The author will always disclose any direct long or short equity, debt or option position in any stocks written about as of the day of publication, and will not trade in any stocks mentioned for three days (72 hours) after publication. Full disclaimer is at the bottom of the page.
August 22nd, 2008 at 8:16 am
Wow Thank You for the Newsletter magazine website !
once again STOCK GUMSHOE RULES!
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August 22nd, 2008 at 8:41 am
Selling covered calls (what all these refer to!) is a dangerous game. I can’t think of anything more dangerous than selling calls naked. Hmm… umm.. besides playing with futures, there isn’t!
Sure, you have the stock but would you really part with it? Better ask yourself that question and ensure your alter-ego gives you an honest answer.
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August 22nd, 2008 at 10:00 am
Actually selling covered calls is one of the less
risky options strategies. Selling covered calls is the only options play that you can do with an IRA account. Getting called out of your stock ends in the most profitable outcome for that strategy.
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August 22nd, 2008 at 2:13 pm
Selling a covered call is equivalent to selling a naked put. Both strategies have exactly the same risk profile. Selling options can be a profitable strategy if you know how to manage the risk you have undertaken, but you are definitely “swimming with the sharks.”
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August 22nd, 2008 at 10:08 pm
At one time Jeff Clark, of Stansberry Research, edited “Advance Income” for under $100./yr. (My last issue is dated 04/08, believe it!)
Today the option based income report goes for $4k/yr. It’s much more actively traded of course, but Jeff has been “light’s out” in 2008!
According to Porter Stansberry, they might doubled the cost again. For those who are comfortable with this type of income trading, how comfortable are you paying $8k/yr. for the service?
For us TA’s, it might work best to use the $8K for the option premiums outright & use our own entry/exits. Just don’t get greedy, that 50% rule would satisfy me most of the time.
What say you other TA’s?
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spreadtrader reply on August 23, 2008 12:47 am:
I’ll address comments #2-#5. I’ve been trading commodity futures and options on futures for 8 years. It hasn’t given me warts, leprosy or caused me (or my account) to die and go to hell. It isn’t “dangerous”. It has added risk because it involves the magnification of LEVERAGE. However, if you learn to understand leverage and learn to control and manage risk, trading futures is less risky than….blindly following the buy “recommendations” of any newsletter writer in business……..period.
It is true that selling covered calls is a reasonably safe strategy that used properly can reduce the cost of trading and add income to the portfolio. It is not the only options play that you can do with an IRA. You can also buy naked calls and puts with an IRA. You cannot SELL naked puts or calls with an IRA (unless you have a commodity trading IRA account). Check with your tax advisor.
Selling a covered call is NOT exactly the same as selling a naked put. If you sell a covered call and the option gets exercised, your stock gets called away. You no longer own it. You get to keep the premium you were paid for the call and the difference (gain) between the price you paid for the stock and the strike price (the price at which the option was called away). In short, you make money on the trade if the option gets exercised. (You also make money if the option expires worthless and you keep the stock, as long as the price of the stock doesn’t go down more than the premium you were paid for the call).
On the other hand, if you sell a naked put and it is exercised, the stock is “put” to you at the strike price. In other words, you become the proud owner of the stock instead of having it called away, the complete opposite of what happens in the covered call scenario. When the put is exercised, you will have a paper loss. Here’s an example. Let’s say you sell a 25 put in XYZ when it is trading at 28.00. You are paid $100 or $1 per share for selling the put. At expiration, XYZ is trading at 21.00. The 25 put is “in-the-money” so it is exercised and the stock is “put” to you at 25.00. You’re now holding a stock you bought at $24.00 ($25 strike price minus $1.00 option premium paid to you); and on paper the stock is worth 21.00. If you sell the stock at 21.00 you lose $3.00 per share.
I’ve posted ad nauseum on option trading and option newsletters in the Gumshoe forum. Options are tricky and not easy to learn to trade. The reason is that there are 3 components to option pricing; and taken together, most people don’t understand how they work. The three components are: a) price of the underlying security; b) time; and c) implied volatility (the most difficult to understand). If you take the time to learn how to trade options, you can do it.
Most option newsletters (including the Stansberry ones) charge outrageous sums because they count on the LEVERAGE of options to appeal to an investor’s sense of greed. They post past trade gains of 806%, 1,427%, etc., when the fact is that in sheer dollar gains, the constraints of sound money management practices in your account prohibit you from employing the leverage necessary to make real money in these trades. (I can explain this further if anyone says they are interested). Additionally, they only tell you about their hypothetical gains…not gains based upon REAL TRADING. That’s a bogus statistic, not to mention a tip that they can’t deliver on their promises. Finally, the option newsletters only tell you about their winners…they usually don’t whisper a word about their many, many losses. (If they say they only have winning trades, they are simply lying to you.) They also don’t tell you about liquidity, slippage, transaction costs, etc…..all factors that subtract real money from your bottom line.
I wouldn’t pay anyone $8,000 or $4,000 or $1,000 or $100 to blindly give me option picks. The reason is that I know how to read a chart and I know to trade. If I were busy (and I am) I might rely on a modestly priced service to give me ideas, assuming they were good ideas. However, for $4,000 or $1,000 or less you should be able to purchase option screening software (I own none) that will spit out ideas to you on a daily (or at least weekly) basis. Simply stated, I don’t believe that mewsletter writers (including option newsletter writers) can effectively time trade entries. Additionally, they are woeful (as in “nowhere to be found”) when it is time to tell customers to exit a trade, either with a profit or (more importantly) a loss. Most of them make that your responsibility…….and for that, you have to know how to trade. Get where I’m going?
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Curtis reply on August 24, 2008 1:29 am:
The percentage trade gains, as opposed to the dollar gains, would mean then that they are betting small, correct? So yes, I would be interested to know of these sound money management practices that reduce the amount of leverage used to make real money in these deals. And of course, what you recommend to offset them. Curtis246.
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spreadtrader reply on August 24, 2008 8:19 pm:
Just so I’m quoted or paraphrased accurately, this is what I said: “the constraints of sound money management practices in your account prohibit you from employing the leverage necessary to make real money in these trades”.
This is what I mean……Let’s say we’re talking about someone with a $50,000 account. Diversification theory says that you shouldn’t put all of your eggs into one basket. So let’s say you’ve decided that adequate diversification calls for you to spend no more that $5,000 (10% of your account) on any one stock. You’ve also decided that for purposes of money management that you can afford to lose no more than $1,000 (2% of your entire account) on any one trade. (I’m no expert on either diversification theory or money management, so you’re encouraged to read-read-read.) Many novice options traders increase their leverage based upon the cost of the option in relation to the size of their account instead of the maximum loss that they can prudently risk. This is a mistake.
For example, let’s say XYZ stock is trading at $50.00 and the next month’s expiring 50 calls are trading at $2.50. Based upon his diversification profile Trader A buys the stock ($5,000). Based upon his risk profile Trader B buys 4 calls ($1,000). Equating diversification with risk, Trader C buys 20 calls ($5,000). The options expire and XYZ is trading at 49.00. Trader A is down $100 on paper, but still in the stock and 9.00 away from his money management stop. Trader B lost $1,000; and while this fit his risk profile, there are additional factors in trading options that make them more risky than trading stocks. Hence, the additional risk should be compensated for by reducing the percentage (and in turn, the dollar amount at risk)
Trader C lost $5,000 and a full 10% of his account, a loss that will eventually lead him to ruin if he repeats the pattern. Also, if the stock closes at 52.50 on expiration Trader A makes $250, Trader B and Trader C break even. It’s only if the stock closes above 52.50 that Traders B and C begin to make money and enjoy the advantages of leverage.
Two additional factors that make option trading more complicated and more risky than stock purchases are the concepts of implied volatility and “delta”. Implied volatility (IV) is the combination of factors that affect the fair value of an option at a given point in time. As option IV rises so does the price of a given option. Together with the price of the underlying security and the time until expiration, these are the components of an option’s price. Investors want to avoid purchasing options with high IV as they are “expensive”. However, many option buyers who “time” the market do not understand this.
The concept of “delta” means that an at-the-money option (our 50 call in the XYZ example) has a 50/50 probability of expiring worthless. An out-of-the-money option has an even greater probability of expiring worthless; and in fact, about 80% of all options expire worthless. I don’t know about you, but I don’t like those odds.
My point is that even Trader B who purchased the 4 calls that were prudently within his risk profile for purchasing STOCK should consider purchasing even fewer OPTIONS because of the increased risk of loss. The “bets” should be “small” because successful trading is first and foremost about CONTROLLING RISK. Therefore, the number of options that can prudently be purchased by many investors means that you have to have a number of winning option trades at “806%” to make up for the likely multitude of losers you will have simply based upon the statistics of option trading. In fact, it’s why in many respects option selling is far less risky than option buying; and I have personally made more money selling options on futures than buying them.
ProBhi reply on August 29, 2008 3:13 pm:
Is OptionsUniversity (their basic options course is around 350$) a good place to start learning?
Or other options for learing Options?
Thx
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StockGumshoe reply on August 29, 2008 3:37 pm:
I don’t know OptionsUniversity personally (perhaps other readers do), but I would always recommend a thorough review of the free resources first. There are many, I like to suggest that folks start with the CBOE’s “Options Institute”:
http://www.cboe.com/LearnCenter/Tutorials.aspx
spreadtrader reply on August 30, 2008 7:49 am:
I’m with the Gumshoe. I like learning to trade for FREE. While the CBOE tutorials are good, I have a comprehesive 3 part options course I’ll GIVE you (I’ll even give it to the Gumshoe). It’s the best FREE resource on options I’ve ever seen. Beyond that, there are books on options too numerous to list. I’ve read a number of them, but I get them for free at my local university business library (great resource). If you come into the forum and find a post with my name on it, whisper me your email address and I’ll send you the 3 part course on pdf.
Alan Friedman reply on September 12, 2008 5:20 am:
thanks for that informative piece with examples. I still need to read and re-read it to digest the process. I have tried learning options via different internet sites but somehow it hasn’t sunk completely in thru my thick cranium. For example, in and out of the money. So yes, I would be interested and thankful for spreadtrader’s hints. Thanks
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August 25th, 2008 at 2:59 am
Thank you, thank you! I’m new to trading and you have put this all across in the most understandable language yet. I had not heard of Implied Volatility. No one has ever brought that up. Before I begin, I am trying to get a handle on the risk side. But on the time aspect, I just thought that picking a longer expiration date would lessen the risk by giving more breathing space.
Your examples were great, re: Purchased calls. Would love to see how it would be different via option selling. Sorry about the paraphrasing.
Now, on ‘delta’ I gather that 20% of traders then are in-the-money, but I don’t see the correlation between the 50/50 probability and the word delta.
On those who try to ‘time’ the market, are you suggesting that they are running out of time? Getting in too late, after the price has gotten too expensive?
I like your style. Would love to follow any recommended reading or study material. Many thanks again for the detail and the depth.
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August 25th, 2008 at 7:36 am
Remember that option IV may go up or down. The underlying price of the security may also go up or down. But the time value of options will ONLY go DOWN. This is the option seller’s primary advantage. So each day the option seller is making money on that component of the option price regardless of the other option pricing components. In the last 30-45 days until expiration, this advantage is dramatic.
However, when I say “time the market” I mean stock pickers who try to time the highs and lows of price swings while disregarding the option’s IV level. The option’s value may be inflated significantly due to high IV levels, yet the stock price may be relatively “low”. This is why the price of a stock can go up, yet the corresponding price of calls go down (as option IV declines).
“Delta” is simply a Greek word used to describe the probability associated with an option’s price at a given point in time that it will expire in or out of the money. It is one of “the Greeks” that is used to describe option pricing concepts. Others are Theta, Vega and Gamma.
If you’re interested, go into the Gumshoe forum and check out option threads where I have posted. There, you can whisper me your email address and I’ll send you a 3 part comprehensive options course that will answer all of your questions. It’s the best FREE resource on option trading that I have ever seen….and I’ve read all of the books….well, most of them.
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spreadtrader reply on August 25, 2008 7:46 am:
I guess “Delta” is a Greek letter, not a word. It means “change” I think.
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DARIN reply on October 19, 2008 11:15 am:
PLEASE could you forward to me the 3 part series you speak of it may help… thanks
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August 25th, 2008 at 11:39 pm
Ok. I get the theme now. Look at the ‘whole’ picture. The guys who are timing the market are only looking at the stock price, to their detriment. Just like the guy in the earlier examples, who put in 10% to risk, based solely on the input figure and not the potential bigger figure of a loss! I’m getting there. Include ALL risks. Bet small. Spread it out.
Yes, I did want to ask of other works of yours, as I’m sure there must be more and not to belabour this point any further. And yes, I have come across ‘the Greeks’ as another tool or point to further investigate.
Will go dig up in the other threads. Thanks a million for the time.
Curtis.
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August 26th, 2008 at 4:30 pm
Actually there are lots of option trades you can do in an IRA; it depends mostly where you have your account. In mine, I can buy calls and puts, and I can sell covered calls. In my brother’s account (different firm), he often sells cash-covered puts on stocks he wants to own.
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spreadtrader reply on August 27, 2008 4:26 am:
I’m sorry, but what you can or can’t do with an IRA depends entirely upon the tax laws. I’m not a tax expert, but I do have an IRA in a commoditiy futures trading account where I frequently sell naked calls and puts using margin. As I said somewhere above, check with your tax advisor.
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spreadtrader reply on August 27, 2008 9:36 am:
Of course, if a particular broker won’t permit you to do something that you’re otherwise lawfully able to do, that’s a different issue.
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October 23rd, 2008 at 4:42 am
Learn more about the Greeks here. Did you visit the site with a free options trading course? - As they say: “You make money whether the market goes up, down or sideways”
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