Making Money with Options

Advertisement

I read the following (slightly edited) comment on a forum:

“I believe that the no retail options traders consistently make money.  Arguments for using options make no sense:

  • Hedging: the best form of hedge is going to cash.
  • Leverage: Can get enough with margin
  • Non-directional income: Cash is non-directional. Don’t make trading complicated

The bid ask spread is massive. How can retail traders overcome that?  My point here is that options are a skimming operation, nobody makes money but the house.”

While it’s true that trading options is not for everyone, I can find no sympathy for the person who posted those thoughts. It’s fairly obvious that he (doesn’t sound like a woman wrote this) has had some bad experiences and has to find someone/something to blame. It’s pretty obvious that our poster doesn’t understand much about options, or investing in general.

Hedging

When a trader has 100% in cash, there is no way that can be considered as a hedged position. By definition hedges are never 100%. A hedge is a position that offsets, or partially offsets, the risk of owning a different position. When a trader moves to all cash, there is nothing being hedged. A true hedge would involve selling part of a position and keeping some cash on the sidelines.

When trading options there are numerous methods that can be used to partially offset risk, and that’s what makes options so versatile. Options can be bought or sold to hedge a trade. Spreads can be devised that both reduce risk as well as offer the opportunity to earn extra profits. Two simple ideas that are commonly used to hedge a stock position are the writing of a covered call or the purchase of a protective put. Options are extremely useful as hedging tools.

Leverage

I must agree that margin affords ample opportunity for leverage, but our poster misses the point.  Leverage is for option buyers who pay a relatively small premium to control many thousands of dollars worth of stock. That’s leverage, and it has nothing to do with margin. The nice feature about option ownership is that leverage can be used with a bullish (buy calls) or bearish (buy puts) outlook. I’m not an option buyer, but I understand the attractive leverage that is available to the small investor.

Income

Cash may be non-directional, but it’s also non-income-producing (at least in today’s very low interest rate environment). His statement has nothing to do with options.

To generate income, one sells option premium (hopefully as limited-loss spread positions and not as naked shorts), looking for the market not to move outside the trade’s profit zone. The trade can be placed with a bullish, bearish, or neutral bias. Again, that shows options to be truly versatile investment tools. This poster probably sold some naked puts into a severe decline and decides that the retail trader cannot win.

Selling these income-generating spreads is not a low-risk trading method. Seeking income from option’s time decay requires more than patience. It requires excellent trading skills and judgment because knowing when (if) an adjustment is necessary is the key to long-term success. Positions must be closely monitored for risk. Traders who ‘set them and forget them’ are not going to make any money on a consistent basis.

Bid/Ask spreads

When markets are wide, only a fool pays as high as the offer or sells as low as the bid. Wide markets allow much room for negotiations.

Options trading requires skills and an understanding of the variables that affect option prices. It also requires a better attitude and education than that demonstrated by the sour grapes poster. Being realistic, we know that not everyone wants to hedge positions or reduce risk. However, options are available for a variety of investment objectives and a majority of investors would benefit by learning to use them efficiently.

Follow Mark on his ‘Options for Rookies’ blog: http://blog.mdwoptions.com


Article printed from InvestorPlace Media, https://investorplace.com/2011/02/making-money-with-options/.

©2024 InvestorPlace Media, LLC