cthree

You're more serious than I am. I only trade with my own money. You could deposit $50 in my bank account by becoming a Gold Member and I promise to invest it for myself

I have no problem with you playing along at home but I have no interest in investing other people's money in the markets, only helping you do it yourself.

Did you buy those puts I told you about a few posts back? If so you're well on your way.

cthree

[QUOTE=AZDavid,Aug 22 2008, 09:36 PM] Buy YGE at $15 and sell after a 20% gain.

Penforhire

I can't argue with success but options take the risk of losing every penny if you're not in the money when it comes due, no? That seems like a big throw of the dice!

cthree

^ Well sure but stocks have the same risk of being worth $0 if the company becomes insolvent. Volatility doesn't necessarily equal risk. As an example let me quantify a trade for you, stocks vs. options and then judge for yourself the REAL risk of loss in monitary terms.

I recently bought 10 NVDA $15 October 08 call contracts for $0.60 per option (100 options per contract, $600 total investment. That gives me a total of 1000 options at $0.60 each. The stock was trading at $13.6X at the time I bought them. That's roughly 44 shares for a $600 investment.

Two days following the purchase the price of the stock went to $15 and the options went to $0.90. That's a 50% gain but more importantly the total value of the investment went up to $900. To get that sort of gain in the 44 shares the price would have had to go up to over $20/share. More importantly to have made the same amount of money (the reward) in the stock I would have to have purchased 214 shares, risking $2921.10 x-fees to do it. That's a risk reward of 2921:300 based on a 10% move in the stock price vs 600:300 (2:1) for the options.

Should those options fail to appreciate, as can happen, it would be equivalent to the stock losing 20% over the same period of time and depreciating by $600, the total amount of our options investment.

So, you see, saying that you lose the entire investment is technically true it paints a distorted picture. You actually have a lot less money at risk on the trade, 80% less. For the same $2900, let's call it $3000, I would have had to invest in NVDA to make $300 on a 10% gain in the stock price I could have made 5 separate option investments thereby diluting the risk further.

I'm not saying that you should trade options like you trade stocks. Earlier I noted some important differences. Stock traders typically put 80% of their money in stocks full-time even if they aren't paying. Most of their assets are at risk all the time.

When you trade options you need to be FAR MORE aware of risk and you need to be more selective about the trades you make. You can't simply by calls in a company because it "looks good". You need to have a real sense of the fair value of the stock and you must have clear sight of a catalyst that will move that price. If you go into options trading and trade them like stocks, buying securities willy nilly then you'll get crushed because, as you say, options have a best before date.

If you can understand risk and have a knack for calling moves before they happen options can let you capitalize on those opportunities without committing a large sum of assets to the trade, even if you're wrong 25% of the time.

It's probably fairer to say that options carry a much smaller margin for error that stocks do and coupled with much higher volatility can lead to things going pear shaped in a hurry. It's the increased volatility however that leads to such huge profits in a short period of time. If you are disciplined and and precise they can be just the thing. Like a chainsaw they are devastatingly effective but dangerous if handled poorly.

Penforhire

Thanks for more explanation. I'm not an experienced options trader. I see your view and understand the massive leverage of option. The writers of several books I read mention how they made killings with options.

If the price does not move I lose $600 forever (throwing away the options). If I own NVDA and it goes down 20% I can hold it if I expect it to come back. I suppose a similar choice I could make, given enough bankroll and conviction, would be to exercise the option and hold the stock.

I like the chainsaw analogy. My friends know they shouldn't let me handle power tools...

PearlwhiteS2k

Thanks for explanation Erik

Nate

cthree

Again the real risk and the logic is somewhat distorted. I know it's hard for people to get their heads around, it takes some retraining.

If you lose the options and they go to $0. You have $600 less than what you started with BUT you have no risk. You can't lose any more than that. If you hold the shares after a 20% decline as described you have $600 less BUT the $2300 you've still got on the table is still full at risk of further loss. You are risking $2900/3000 with stocks, only $600 with options. You stand to make a large return by risking very little capital.

What if NVDA subsequently falls to 30% of the original price? You're out now over $900 and falling. Again, the logic that says "I should keep my money in an investment that is losing me money because someday things may change and I could make back what I lost" is fundamentally wrong and bad.

Do you ask yourself "Should I buy a stock that has declined by 20% in the last month?". You should. Owning 200 shares which are down 20% is no different than having none and buying 200. The two are identical financially and logically the same. Each day the market opens the score is erased and you start over. You can start with shit and hope for the best or you can start from scratch. The only one keeping track of your mistakes is you and your account manager. If you make a mistake one day don't carry it forward because you're too proud to admit it.

If you buy a stock or options that go in the shitter then you cut bait and go fish somewhere else. There is no sane argument for tying up capital that could be making money. It's taking up valuable space which could otherwise be productive. DONT MARRY YOUR INVESTMENTS.

Stocks are cash, cash is stocks. We convert cash to stocks so it can earn a higher return than as cash. If it's not then you need to convert it back to cash so it can be converted into another stock which has a better chance of making a good return. It's money man and if you make an investment which doesn't perform as you expect it to then you do something about it.

Settling for performance below reasonable expectation is why people are earning 10-15% (if they are lucky). Choose your investments wisely, make a plan, invest the money until you reach your goal or until the plan is screwed. If you invest in a stock or option or whatever expecting a jump on earnings, a sector rotation, some news or whatever and it doesn't happen you're done.

Discipline is not following a broken plan. It's not making a new plan when the first one fails. It's packing up your money and moving on. Accept your loss YOU WILL LOSE MONEY, LOTS OF IT. You have to. If you can't lose you also can't win, there is no game. Accept that some of your trades will go sour, it happens. The losers hang with the losers. Winners cut their losses and find another way to win.

NVDA dropping 20% when you expect a 10% pop is an epic failure. Discipline dictates you eat the loss and sell. You went from risking your money on a 10% pop on good information and a clear idea and expectation of what will happen to risking your money on a 37.5% pop based on nothing but bruised pride, stubbornness and hope. If the stock can't go up 10% it's sure as hell not going to recover to the tune of 37.5% and save your plan (unless that possibility is part of the plan).

The measure of risk is really the measure of the likelihood your plan will be successful. You need to re-evaluate that frequently (how often depends on your time horizon, on a short term 1-2 month trade it might be as often as every week or few days). Risk will fluctuate constantly and when you plan for an investment starts to look less and less likely to be successful you need to be willing to cut the cord.

Penforhire

You're right that I need to cut my losses sooner. Somehow that's easier in my fantasy league than real life.

I'm down on an SQM position, having bought on the way down at least, but I still like its "story" and future (lithium for batteries) so I'm holding it while I could have saved some pain by admitting fertilizer stocks had further to drop. I should have rotated out of materials with everyone else!

Same for a MRK position but it is coming back sooner.

Options, eh (his friend hands him a chainsaw)?

vAnt

Just wondering, what are you views now? I didn't follow through with your advice, but it's at $1.10 now and seems to have power strong vol.

cthree

^ my views haven't changed based on an hour and a half of trading volume.