Just looking at the news today (Middle East, Euro, Impending Fiscal Contraction) and feel like I wouldn’t mind being short the market for a while or at least heaging some risk. Also reading about Amazon Prime now offering streaming movies and tv made me look up NFLX’s chart. I don’t want a naked short on SPX, NFLX or anything else due to the risk involved. Thus buying put might be a good option for me. Can anyone with experience of buying options for their personal account please give me some advice? I’m interested to know what online brokers give good coverage and also is it prohibitively expensive to buy options for relatively small amounts on a retail account?
if you are buying less than $500 worth usually like 10% of your returns will get eaten up by trading fees to get in and out of trades. if you want volatility trade options on faz. for what it is worth I do not recommend trading options - it is so risky that even if you make a winning bet or two you will ending up losing this money at some point. it is just very risky and you can see your position wiped out in a matter of hours if not minutes.
I don’t think that Carson is asking to trade in and out of options regularly. He/she’s just looking to control some risk. Buying a put to hedge a long position isn’t terribly risky; max loss is the initial investment. It is true that one should be careful about fees. The fees and b-a spread on options are often substantially wider than on corresponding stocks. Which retail account do you use?
I’ve had the same thoughts. I may buy some puts on SLW if it goes mid-40’s. Just as a protective put, not speculation. Be careful on Netflix though: http://dealbreaker.com/2011/02/whitney-tilson-why-we-covered-our-netflix-short/
Thanks for the comments. Realistically I would be looking at protective puts. So maximum loss equal to initial investment. I was looking at opening an account with Interactive Brokers. Anyone use them? I’ll take a look at their fee structure in detail later. If I was buying a position for say $1,000, I wouldn’t want approx 10% of that eaten in charges so perhaps this isn’t suitable for me. Read that piece on SeekingAlpha - thanks. I haven’t really done enough research on Netflix to trade on it yet. But with the share price more than tripling in the last year plus forward P/E of 50x plus extra competition from Amazon etc makes it look like a potential opportunity.
IB is ok, the user interface is pretty bad imo but they have access to a wide range of products and they are pretty cheap. You could short NFLX vs. a basket of similar companies. For the SPY, I’d look into a risk reversal or a spread - buying puts is expensive. …separately, don’t trade options on FAZ.
If there’s one thing I have learned while trading it’s to not screw around with options unless you’re selling covered calls or something mundane. I have a lot of good stories (bad trades) about what not to do. Fortunately I’ve learned my lessons at a young age.
I think the key is that there’s a difference between trading options and using options, in the same way that trading oil is different from buying oil in order to use it. Trading options is highly risky if you don’t know what you’re doing, in part because of the embedded leverage. Buying $1000 worth of stock, things may go down, but it’s fairly unlikely that you’ll lose your entire investment. Buying $1000 worth of options, there’s a substantial chance of losing it all if they expire OTM. Selling options for a bit of premium is really the riskiest thing if you don’t know what you’re doing, and especially if you aren’t hedged by holding or shorting the underlying asset.
Like everything else, options are not a magic bullet. In the absence of compelling analysis based on a thorough understanding of a strategy, you have to assume what you’re buying is correctly priced and you’re getting what you’re paying for probabilistically speaking. With all due respect, I don’t think someone with the OP’s limited understanding of options (self-confessed I think, and which is of course no shame) has any business trading them. Even if doing so did not cause significant losses, as other posters have point out it might, it is almost certain to be a waste of time and money probabilistically speaking.
An illustration of what I mean by “probabilistically speaking”: Say someone offered you, for a fee of $1.00, the chance to bet $50.00 on a fair (that is, 50/50) coin flip, so that you’d receive $100.00 if you won and $0.00 if you lost. That might seem like a good strategy in retrospect if you did it and won, but of course it is a bad idea probabilistically speaking because the expected winnings are zero (0.5 x $0.00 + 0.5 x $100 = $50, exactly what you started out with) and it costs you $1.00 to employ the strategy. That is probably a very good analogy for any trade you’re thinking of doing that consists of buying options, by the way.
CW - What if you find yourself in a situation where you need $100 and you only have $51? In that case someone may be willing to pay for the privelage to win or lose $50, regardless of the EV. Probabalistically speaking, options are rarely priced ‘correctly’ as IV is usually different than realized.
Like, say, a hedge fund manager whose annualized part-year performance won’t entitle her to any incentive compensation? Seriously, I agree there may be times when people decide a strategy like that makes sense for them, but they should understand it before employing it. Obviously people do that all the time when they buy lottery tickets or go to casinos, etc. I don’t think such a strategy has much place in a sensible investing approach, however. Everything is probably always mispriced to a greater or lesser degree; that doesn’t mean buying it (or selling it, or whatever) is a good decision probabilistically speaking (i.e., is likely to make you money). You need compelling insight about the mispricing and other factors, which is difficult to say the least.
Captain Windjammer Wrote: ------------------------------------------------------- > Like, say, a hedge fund manager whose annualized part-year performance won’t entitle her to any incentive compensation? Haha, sounds about right. Well played.
I’ll give you another scenario. Let’s say I am holding SPY at $130. I’ve decided that I will get out if SPY falls below $120, but I’ll get back in if it stays above $120. Things are kind of volatile right now, it could fall below and come back up several times, and if I follow my strategy, I’m going to rack up a bunch of commissions and I am also going to be concentrating on managing SPY trades instead of other opportunities. So I buy a $120 Sept Put, currently at about $4.60. Now I don’t have to worry about dipping in and out until September, and if the volatility passes quickly and I don’t need the put, I sell it for remaining time value, which decays at about 50 cents per month right now. If SPY collapses, I sell both my SPY and the put, realized at $120 + remaining time value - transaction costs. Now, from a pure probabilistic sense, if everything is efficiently priced, then all I’ve done is pay a few more transaction costs to achieve what I could have done myself. But there are a bunch of reasons I might still want to do this: 1) as the S&P crashes, I start to panic without the put. It becomes harder to stay rational. I’m willing to pay some transaction costs up front for the benefit of being able to stay rational while the world is going to hell. 2) By having the put, I can spend less time worrying about what is happening to SPY and free my mind and time up for other opportunities. If I have no other things that we should be watching, then my time is better spent managing SPY without the put, but if there are, then I should pay the transaction cost and use my brain for other things. 3) I may have extra information or analysis about the underlying that suggests that the probability of expiring in the money is higher than the probability of expiring in the money implied by the option’s price. Even though I think the option has a higher likelihood of expiring in the money than priced in the option, the underlying is still volatile and I’d like to cut my largest risk. Finally, your example of a 50-50 $100/$0 payoff should not be priced at $50, because this is a risky bet. In general, I should not prefer taking the bet to having $50 in my hand. In order to take risk, I would need to pay less than $50 for a $50 expected return. That’s the risk premium. So if my option is priced at $1, then that is a good deal as long as it’s going to cost me less than $49 to risk something with an expected return of $50.
Thanks for the response. I’m not going to reply in detail, I was just trying to get a point out there. I will say (again) though that I do agree there are circumstances where the sort of thing we’re talking about makes sense, but things need to be understood properly. I’d also say that my point probably also applies to the entire exercise(s) you’re talking about - likely to be a waste of time and money probabilistically speaking - but that is a larger argument (which I’m also not interest in getting into right now). Obviously if you have analysis that makes it worthwhile that’s a different story, as I said a couple of times above, but that is very hard to achieve. I didn’t say anything about how my example should be priced, nor did I mean to. I was simply trying to construct an example to demonstrate what I meant by “probabilistically speaking”. I do think it goes without saying that probabilistically speaking the sort of thing we’re talking about is generally a losing proposition after fees, however, even after taking account of any risk premium.
Captain Windjammer - What strategy would you suggest for someone looking to hedge a (relatively) small retail account? Should I forget about options and buy a short SPX ETF for instance? Obviously a lot of people are long gold right now as a partial hedge. I appreciate your advice on the risks involved in trading options for novices. By the way, if anyone can recommend some good literature on option trading strategies I’d appreciate it. Is it something best left to professional traders in the main?
Carson, Returning to the comment regarding trading costs: sure the bid-ask can be very wide, but this is typically for only highly volatile small cap names and also the longer the time to maturity the wider the bid-ask. The bid/ask on the SPY and other indeces is in pennies, certainly no where close to 10%. And as for commissions, I use Interactive Brokers to trade options and I couldn’t be happier with them. $1/contract or less and the only “catch” is that you need to generate $10/commissions per month or you have to pay a fee = ($10 - minus commissions paid during the month). Full disclosure: I have exposure to IBKR stock and options