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Do You Know Your Options?


Option-trading strategies suit any investment philosophy.


When some investors hear about options, they get very excited and can't wait to begin trading. That's usually the result of hearing some ultra-hyped commercial that promises fantastic profits. Unfortunately, those profits are seldom realized.

On the other hand, I recently heard from someone who has always been steered away from options because he'd been taught that options were too risky. After reading some of my writings, including my recent book, he now believes he can use options profitably. But he wants to take his time, and be certain that he understands what to expect from any option investment that he makes. He wants to be certain he grasps just how much he must risk to earn specific rewards. I applaud this cautions approach.

Most option rookies fall between these extremes. I know it's important to understand how options work before getting started, and that's something I stress in my writings and coaching. If you're reading this post, then you either have some interest in trading options, or have already been trading and are looking to further your options education.

To the New Trader/Investor (i.e. Option Rookie)

The remainder of this post is directed to the option trader to-be. Let's discuss these questions:

  • What can options do for you?

  • Why bother to use options?

  • Are the stockbrokers who tell you options are too risky telling the truth?

  • Why don't financial planners use options?

After the stock market crash of October 1987, one of the common ideas (oversimplified in IMHO) was to blame options for the stock market massacre. The thought was that the huge number of outstanding naked puts resulted in a put-buying panic by people who were forced to cover their positions. Many of those put sellers went bust. But consider the market makers (and others) who were selling puts to the panicky put buyers. They had to sell stocks to hedge their own put sales. Thus, the put panic resulted in a stock-selling panic. At least, that's one of the unproven theories.

As a result, many brokers became cautious, and chose not to encourage their clients to adopt any option strategy. Why would they do that? To prevent someone who lost money from suing. Never mind that their customers were denied access to the risk-reducing properties that only options can bring to a stock market portfolio; these brokers were out to protect themselves. No surprise, as this practice continues to this day. But the bottom line is that some brokers still discourage options from being used, telling customers that they're too risky. The truth is that too many brokers have no idea how options work, and rather than appear ignorant, they avoid the topic.

Financial planners aren't required to learn about options, and that makes it easy for them to simply ignore options, and tell any client who expresses an interest in options whatever is necessary to make the client lose interest is using them.

So, if you choose to enter the options universe, what can you expect? How can options help you?

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No positions in stocks mentioned.

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