The Agony Of The Options
I have always considered myself a savvy investor. My father taught me about mutual funds at the age of 12, and I opened my first brokerage account when I was 20. But after spending two days learning to trade options, I was humbled.
As an investor, I understand the appeal of options. Options contracts, which give the right but not the obligation to buy or sell stocks, indexes, or other financial instruments at a specific price in return for paying a premium, can help hedge a portfolio or generate income in a market that's moving sideways. That, plus cheaper online commissions and improved trading technology, helps explain why the options market is booming. In October monthly options trading volume hit an all-time high of 155 million contracts, up nearly 44% from the previous year, according the Options Industry Council, a trade organization.
Using options can be hazardous to your portfolio's health if you don't know what you're doing. These days, you can get educated dozens of ways, from books and Web sites to classes and personal tutoring.
Upon the recommendation of an industry insider, I signed up for the two-day introductory course at Optionetics, designed to teach individuals how to trade options on their PC or via a broker. The Redwood City, Calif., financial education firm has been giving such seminars for over a decade. Since 1993, more than 50,000 people have attended its courses in major U.S. cities and abroad. Because I was reporting a story, I didn't pay the tuition, which typically runs around $4,000.
My 120 or so classmates at the Brooklyn (N.Y.) site in early November were a diverse group. I'd expected mainly retirees and boomers, but there were younger students, too. Patrick Pasteur and Zachary Simmons, the 24-year-old owners of a social services agency in South Orange, N.J., decided to take the course after hearing about it at a Donald Trump real estate workshop. Pasteur had tried his hand unsuccessfully at options trading, and Simmons was hoping to enhance his portfolio.
My instructors, Ken Farber and Peter Achs, were lively lecturers. They peppered their talks with sarcastic banter and riffs on personal finance diva Suze Orman. They spent much of the first day on the basics, starting with the difference between a put (a contract giving you the right to sell shares at a preset price) and a call (a contract giving you the right to buy at a preset price). But we weren't starting from scratch, either. Even before the first class, we had to read three chapters of a textbook and watch a DVD.
From the beginning, the instructors encouraged us to put our pens and pencils down and just listen. After all, the material was already in the three coursebooks and set of DVDs that students get. To drive home key concepts such as delta (a change in the option value based on a move in the underlying stock) and open interest (the number of outstanding contracts), the instructors projected the material on two 10-foot-high screens in the banquet hall-cum-classroom. The lectures, broken only by several 15-minute breaks and a lunch hour, were interactive. Farber and Achs used real-time options prices and called on students to answer their questions.
We had homework, too. After the first day, we had to construct three bull call spreads using the January '06 options on online DVD rental site Netflix (NFLX ). (A bull call spread is when you buy the call at one strike price, and sell a call on the same stock for a higher price. It's a lower risk strategy than just buying the call -- but less rewarding if the stock zooms.)
The message throughout the course was clear: Keep your risk in check. The teachers outlined rules for setting up a trade. For calendar spreads, for example, we should use at-the-money options -- those with a strike price closest to the current price on the stock. (In a calendar spread, you buy a longer term option and sell a shorter term option with the same strike price and the same stock). More important, they showed us how to exit a position. Under their system, investors shouldn't be greedy. If you double your money on a bull call spread, cash out.
I breezed through Day 1. I could put together a sophisticated trade like a bear put spread. I knew which put to buy and which one to sell and how to place that order with my broker. I even picked up some technical analysis -- parsing stock price and volume movements -- which made it possible to find trading opportunities in the market. So when I arrived on the second morning, I was confident I would pick up the day's lessons with the same ease. But learning to trade options is a bit like learning to speak a foreign language. As we moved on to more complex strategies, I started to get performance anxiety.
Optionetics doesn't pretend everyone will pick it up in two days. It offers a lifetime repeat policy, so students can retake the seminar as many times as they like. Retiree Ken Kasowitz, a former programmer, took his first Optionetics seminar in June, 2004. Since then the 64-year-old has attended the course more than 10 times. He even hit one in London while on vacation. Says Kasowitz: "I always learn something new."
Of course, you don't need a class to learn how to trade options. Gene Cox, a 53-year-old systems administrator in Indiana, has never taken a workshop. He read every book he could find on the subject and hit Web sites such as that of Schaeffer's Investment Research (schaeffersresearch.com).
It's also a good idea to try paper trading before putting your own money at risk. My instructors, both of whom have been trading for more than a decade, say they often use demo programs to test trading strategies or see where old ones went wrong. I've recently opened an account at online broker OptionsXpress (optionsxpress.com), which has a program that lets me trade virtually. With online practice and perhaps a few more times in the classroom, I might be ready to try a complex trading ploy called iron condor for real. Maybe.
By Adrienne Carter