Welcome to Scribd. Sign in or start your free trial to enjoy unlimited e-books, audiobooks & documents.Find out more
Standard view
Full view
of .
Look up keyword
Like this
0 of .
Results for:
No results containing your search query
P. 1
4 Reasons Why Options Trading May Be Dangerous to Your Health

4 Reasons Why Options Trading May Be Dangerous to Your Health

|Views: 16|Likes:
Published by Richard Wiegand
Sign up now for FREE lessons on investing, tips and competitive market timing signals at http://proactinvest.net
Sign up now for FREE lessons on investing, tips and competitive market timing signals at http://proactinvest.net

More info:

Published by: Richard Wiegand on Jan 22, 2012
Copyright:Attribution Non-commercial


Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less





Essential Lessons- Option Income Strategies are Dangerous to your Financial Health
By Richard Wiegand, founder of  
This blog post is an excerpt from the Essential Lessons of Investing Series
Lesson 15
Why Options Income Strategies are Dangerous to Your Financial Health
Whoever named these derivative instruments “options” had a cruel sense of humor. Theyfeel a lot more like shackles… - any options trader
 The so-called option gurus make it seem like a no-brainer. "8-10% per month consistent incomeselling time," "Laugh all the way to the bank with couch potato option selling strategies," etc.,etc. Yet many experienced traders would argue that option selling strategies are dangerous toyour financial health. For traders and swing to intermediate-term trading system developers witha competitive model, it's actually far better to be an option buyer than an option seller. This blogpost will attempt to explain why.
A little personal background
 When I was much younger, I returned from Paris to co-manage an emerging markets bondportfolio with a hedge fund in New York and learned many lessons simply by keeping my eyesand ears open. This hedge fund was run by ex-Salomon Brothers directors and equity traders.They were really good at managing stock portfolios –generating in excess of 30% average annualreturns. One of the things that struck me most was that the hedge fund completely avoidedoptions trading almost completely – no directional or “delta” plays, no time decay or ”theta”plays – not even option hedging strategies like protective puts or collars.At first, I thought that this was because they were kind of old school and needed to hire somefresh blood in order to get up to speed on the greeks. But over the years, I began to realize whythe New York hedge fund that I worked for many moons ago firmly decided to avoid complexoptions strategies. The Paris-based hedge fund that I worked for also cut back on options incometrading because those accounts were going nowhere. The head options trader at the Paris hedgefund sat just across from me – he was well-educated and had superior quantitative-analyticalskills. He liked to put on calendar spreads – where he essentially tried to buy implied volatility(IV) when it was cheap and sell it when IV was rich. Since the accounts that he managed wereessentially going nowhere, he was asked to stop. In all my years in the industry, I have yet tomeet someone who has consistently made money with option income strategies over a prolongedperiod of time (say over a 7-10 year period).I began to think to myself, “heck, I’m a pretty experienced trader and model developer guy.Imagine what all those option newbies must be going through as they embark on the treacherousroad of options income trading!” I realized that I simply had to get the word out about howdangerous options income trading is.
What exactly are option income or option selling strategies?
Briefly said, option incomestrategies are
designed to take advantage of the time decay of options
by collecting (andhopefully keeping) the premium sold.
is the options greek that has to do with
the decay of time value as you approach expiration
. The time decay of options is a mathematical certainty,and the rate of decay increases exponentially as you approach the expiration date. It is said that70% of all options contracts expire worthless. So everyone should be an options seller (orwriter), right?We'd all be pretty stinking rich if this were the case. In practice, there's tremendous skill,experience, capital and psychological fortitude required to manage the risk of an options sellingstrategy. In addition, what many of those sleek options mentoring courses don't tell you is that
 there's a huge difference between the probability of keeping premium at expiration, versus the probably of touching a stop level during the life of the option.
Some of the most popular option income (or selling) strategies include:
credit income spreads
 : bull puts, bear calls, iron condors, butterflies, covered calls (or covered writes),and naked call/put selling. Credit spreads entail buying a call (put) and sellinganother call (put) simultaneously for a net credit (taking in more premium thanpaying out).
debit income spreads
: calendars, diagonals and double diagonals. Debit spreads entail buying acall (put) and selling another call (put) simultaneously for a net debit (taking in less premiumthan paying out).What all these income options strategies have in common (probably best seen graphically), isthat they all try to build some sort of a roof-top over the underlying price movement in an effortto contain the price action. In return for a supposedly high probability range of limited income(about 6.7% of the margin requirement), you are subject to the potential for some pretty
precipitous losses at the wings (anywhere from -12% to -100% of the margin requirement). Thislop-sided potential for losses at the wings is typical of option income strategies and is whatmakes them so dangerous. As an example, the iron condor (as shown below) is designed to profitfrom prices staying inside the price range of the two short strikes (the short 118 put and the short130 call). In this example, the 118-130 range is the
that is typical of options incomestrategies.These strikes were selected based on the 68% probability range
 at expiration
. Doesn't the ironcondor strategy vaguely remind you of the normal distribution bell curve?It should. High probabilitytrades are supposedly what attract option income traders, because the expectation is that prices

You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->