“Big Companies, Big Gains with Tier-2 Equities” Burritt

Just a quick note, since I’ve had quite a few folks write in with questions about this “Tier-2 Equities” teaser for J. Wayne Burritt’s investing newsletter, Easy Money Options.

I don’t know what Burritt’s track record might be, and the track record of options services should always be taken with a grain of salt, but it is clear that all he’s teasing in his ad is the general idea of trading options. He doesn’t note any particular top secret strategies he might have, nor specifically tease any particular options that he likes right now, just talks up this idea of “Tier Two Equities” in a way that makes them sound much more mysterious than what they really are — which is, of course, just options.

I’ve written about several options trading services before — some are focused on something particular, like the Dark Equities teaser from Karim Rahemtulla about buying long term LEAP options, or the Jeff Clark stuff from Stansberry about selling covered calls for income. They all seem to have decent strategies, at least in their advertising copy, and they all talk about their successful trades and paint a picture of a safe and easy investing strategy.

That may be true, depending on your perspective, but here’s just a quick summary of my thoughts for those who are new to options trading … those of you who are already experts, you can move on along now, nothing more to see here:

1. Options are much more volatile than common stocks.

2. Options are much harder to invest in effectively than stocks — not because they’re that much more complicated, but because they are attached to a particular timeframe. If you’re right about a stock’s future and guess that the shares are underpriced and will go up within six months, you’re probably willing to be patient if you were wrong and it turns out to take eight months instead. With options, if you bet on that six month timeframe and it doesn’t work, you get nothing if the shares shoot up a month later. Timing is everything with options, and timing the market is really hard.

2. By all accounts, most options expire worthless (which is an argument in favor of the covered-call-selling strategy). And when you do get the occasional winner, it is psychologically very hard (for some people) to hold on for outsize returns … it’s difficult to be patient and wait for a 3,000% return when you’re already sitting on a 500% return, but it’s hard to make a lot of money in options if you don’t let those huge returns build.

3. Options selling (covered calls) limits your upside — if the stock booms upward, your gain is limited to the price at which you sold someone the option to buy your shares.

4. Options have a limited downside, but that limit is a 100% loss. You very, very rarely see a common stock go bankrupt and go to zero, but many, if not most out-of-the money options go to zero at some point. Ads for options services almost always tout the fact that this is a safer way to trade because you’re putting less money at risk, but folks who are not familiar with options trading might not readily understand that “at risk” for options means a pretty good chance of a 100% loss, whereas with most equities you’re very unlikely to see the floor fall out from under you nearly as quickly or completely.

5. Options for almost all stocks are dramatically lower volume than the stocks themselves — you can check this by looking at the “open interest” for any options contract, that’s the number of current contracts that are open. You can always open new contracts, but there may not be a huge market for that particular contract. This means that an advisor who has a decent number of avid subscribers is not often going to be able to get them all in at the price he recommends, because the other subscribers will drive the price up. Likewise, they won’t all be able to sell at once. This means that the “paper” gains of these services have to be taken with a grain of salt, they likely have many subscribers who, even if they tried, would be unable to get those gains. This is the same thing that happens with newsletters that recommend microcap OTC or penny stocks, the subscribers can easily jolt the price of the shares.

I can’t comment much specifically about Burritt’s service because I don’t know it, and have never spoken to one of his subscribers. In the ad he talks extensively about all the great options trades he has made in the last year or two, but as far as I can tell they’re all oil and gas companies. Is he a great options trader who knows how to pick and ride the hot sector, or did he have hundreds of trades during that time and the only ones that were great performers were the ones in the hot sector of the year? I have no idea.

Some of my best options trades over the past two years were in energy companies, too, but my experience with options is that I have lots of 100% or near-100% losers which are swallowed up by the occasional 1,000-20,000% winners — do keep in mind, however, that I generally use options for small-time bets on interesting ideas and trends, with the occasional puts to protect my larger equity positions … I don’t do much active or short-term trading in options.

From Burritt’s description he does all kinds of options trading — selling calls for income, buying puts for downside protection, trading short term options for quick gains, and investing in long term LEAP options to magnify returns. Perhaps he’s masterful at all of them, or perhaps not.

I don’t have anything against any of those strategies or against options, and as I noted above I myself trade options to a limited degree, but I would always urge investors who are new to this stuff to understand options and the way they work before giving anyone their money to recommend options strategies. Think about what levels of safety and risk you’re comfortable with and how you would react in some hypothetical trading situations, and read up on the basic options information that your broker will almost definitely provide, or that you can get from the folks at the CBOE or any number of investor education websites. After that, it will be at least a little easier to tell whether the folks peddling these services are options trading geniuses, or just full of hooey … or at least, you’ll have a fair chance of evaluating them during the “free trial.”

Many of my readers are active in options trading too, whether because it’s a system they’ve worked out or because they like the income of selling calls