How NOT To Make Money: Trading Stock Options (blog comments thread)

[SteveW]

This thread is for reader comments about our article "How NOT To Make Money: Trading Stock Options". It describes numerous reasons why options trading is rarely profitable.

You can start a new thread, if you prefer.

[SteveW]

A reader asked the following questions (edited, and identifying details removed).

Subject: Your article on "How not to make money in options"

• I am retired, and want to find a stock option trading strategy in order to make some money to supplement my retirement income by trading in my IRA account.
• I was drawn to trading options due to the influence of all the advertisements on how to turn $10,000 into $1Million in less than 5 years, etc.
• I signed up with a 100% money back guarantee trial subscription to [options newsletter]. They charge [$XXX] for 1 year of weekly advisory emails. They claim to use the same successful strategies that large Wall Street brokerage firms use.
• Can you tell me whether you have used other advisory services other than Value Line?
• Have you investigated whether any of the options advisory services are any good?
• If you have over 25 years of programming experience, you still cannot design a program to win.
• Also, the hedge fund you mentioned in the PBS program still failed even with M. Scholes and the other two experts. How can a small newsletter publisher advertise that they will make subscribers many, many times more than their investments?
• You advice may save me $$$ and disappointments. Your response would be greatly appreciated.  Thank you in advance.

To answer your questions,

The only advisory service I ever subscribed to was the Value Line Investment Survey (stocks, not options). It seemed pretty good, and is available in many public libraries for free. At the time, it had a good track record, which it might still have. But they don't promise huge returns, just fairly "normal" ones, slightly better than the market averages. At various times I also subscribed to Daily Graphs and Value Line Options, but both of those only provided statistics, not advice.

I have never used an options advisory service, but I personally am inclined to be skeptical of all of them on the grounds stated in my article: if they work so well, then why are the authors publishing a newsletter instead of making millions following their own advice?

The sales pitch on [website] about [newsletter] is so well written that it looks to me like carefully and professionally written advertising copy. But my question to them would still be the same: "Communicating with your subscribers is time consuming. If your options trading strategy is so good, why don't you just do that for a living? You only get $XX a month from each subscriber. Can't you do better than that by following your own options trading advice?"

Many options newsletters advertise that they will make their subscribers huge amounts of money. I personally do not believe that most subscribers to most newsletters are making huge amounts of money. I do believe that some newsletter writers are making a lot of money, while risking none of their own money in the options markets.

I've certainly written many computer programs, but I never tried to design one to "beat the market". My financial programs only calculated statistics.

The final decision is, of course, up to you, but I personally would not trade options to try to supplement my income, and especially not in my IRA to try to supplement retirement income. In my opinion, it is more likely to result in the loss of money you really need. I think that most financial consultants and retirement planners would probably say the same thing.

If it were me in your situation (which it is not), I would cancel my subscription to the options service and investigate other more conservative ways to make money, ones that are not "too good to be true".

However, if an experiment is worth $XXX to you, then you could keep the subscription, but trade only on paper for the first year. Yes, it will cost you $XXX, but at least you will know whether their strategies look promising or not. That's a fairly cheap experiment because in options trading (real trades, not paper trades), you can lose $XXX quite fast. So if you trade only on paper and then decide that their strategies don't work, you will have acquired that knowledge for only $XXX. If you make the trades for real, you can lose the $XXX plus a lot more.

I am not aware that the large brokerage firms on Wall Street actually make money trading options, and some large brokerage firms have run up gigantic losses in the financial markets. They are often not particularly good at trading. And hedge funds... well, you saw what happened to the one on the Nova program.

So although I recognize that options newsletter sales pitches often sound very attractive, I cannot recommend that anyone enter into options trading expecting to make money, and especially not with retirement income.

I'm sorry not to be able to be more positive, but options trading is marketed as a "get rich quick" scheme. If get rich schemes really worked, everybody would be rich. If options trading really worked, newsletter writers wouldn't have to work so hard writing newsletters and trying to get subscribers. They could just trade options.

[SteveW]

Another reader wrote:

I figured that since I found your website and saw how much effort you put into writing about your shortfalls in the options trading market, I must say I feel sorry for you. I'm making money in options, and I learned from someone who is also very successful at it. I've also lost lots of money but when a position goes against you, you CAN jump on the other side simultaneously and "catch up" with the opposite trade essentially balancing out the loss. In effect never losing money, either win or hold still.

Just a thought, good luck in your other ventures.

The strategy you suggest is basically a long straddle.

It sounds fine in theory, but it assumes that a position that goes against you will continue along its new trend which you can then follow and profit from. You can't count on that.

If the option price goes nowhere after you "jump on the other side" (which statistically is the most likely thing it will do), you lose whatever your losses were on the initial position, plus your entire investment in the second leg which expires worthless.

My question to you based on what you said on your website, "options lose value too quickly" why on earth did you not sell them?

The various option selling strategies require substantial financial resources. For every 1 option you sell, you must either possess 100 shares of the underlying stock, or have enough capital to finance a 100-share trade, which in some cases may be at a price that is arbitrarily high without any specified limit. To someone with large financial resources, option selling is nickel and dime trading in comparison to their total capitalization, and for someone without large financial resources, option selling can lead to financial disaster.

[nathanmeyers]

Excellent, excellent article that makes many good points.

However, I'll rebut one of Steve's assertions from the discussion thread: that writing options is not an interesting strategy. In fact, it's one of the few ways to reliably make money in options. It doesn't give you the swing-for-the-fences returns of options trading but, unlike trading, it actually works. Even Motley Fool has gotten into this game with an options advisory service, and much of their advice involves writing options.

The most common option-writing strategies require a willingness to own or buy the underlying stock, which means you have to start by choosing good stocks and understanding what they're worth. Sounds elementary, but that requires work that many options traders do not do: look for quality investments, not just for appealing price action or volatility. Simple strategies like writing covered calls and puts can turn boring holdings into nice income generators. It works because you're being paid to take reasonable risks, and because you're willing to take current income in exchange for capping your upside potential: that's a bet that you will usually win. More to the point, it works because you are selling assets that, most of the time, eventually become worthless.

Does owning stock in order to write options require "substantial financial resources", as Steve suggests? Depends how poor you are, I guess. After you've blown through tens of thousands of dollars gambling on options trading, I'd think boring old stock ownership would look like a bargain. As to whether writing options is "nickel and dime trading" to the well-heeled investor? It's not unreasonable to expect 10-20% and greater annual returns from conservative option-writing strategies in a flat market. Even the most well-capitalized investors should find that interesting.

For better or worse, retail investors like you and me are increasingly being lured into the options market. New brokers are popping up all the time, commission rates are falling, and even long-established conservative giants like Fidelity are pushing the advantages of options. Some investors will be lured into high-leverage, high-risk trading and make the same expensive discoveries that Steve did. But those who take the time to understand the risks and rewards, and are willing to substitute patience for greed, can do quite well in this game.