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Disadvantages of Option Trading

1.    Taxes.  Except in very rare circumstances, all gains are taxed as short-term capital gains.  This is essentially the same as ordinary income.  The rates are as high as your individual personal income tax rates. Because of this tax situation, we encourage subscribers to carry out option strategies in an IRA or other tax-deferred account, but this is not possible for everyone.  (Maybe you have some capital loss carry-forwards that you can use to offset the short-term capital gains made in your option trading).

2.    Commissions.  Compared to stock investing, commission rates for options, particularly for the Weekly options, are horrendously high.  It is not uncommon for commissions for a year to exceed 30% of the amount you have invested.   Be wary of any newsletter that does not include commissions in their results – they are misleading you big time.

3.    Wide Fluctuations in Portfolio Value.   Options are leveraged instruments.  Portfolio values typically experience wide swings in value in both directions.

The most popular portfolio at Terry’s Tips (they call it the Weekly Mesa) gained over 100% (after commissions) in the last 4 months of 2010.  The underlying stock for the Weekly Mesa is the S&P 500 tracking stock, SPY, one of the most stable of all indexes.  Yet their weekly results included a loss of 31.3% in the last week of November (they have added an insurance tactic to make that kind of loss highly unlikely in the future, by the way).  Three times, their weekly gains were above 20%.

Many people do not have the stomach for such volatility, just as some people are more concerned with the commissions they pay than they are with the bottom line results (both groups of people probably should not be trading options).

4.    Uncertainty of Gains. In carrying out option strategies, most prudent investors depend on risk profile graphs which show the expected gains or losses at the next options expiration at the various possible prices for the underlying.  These graphs are particularly important to check out when placing initial positions, and it is also wise to consult them frequently during the week as well. 

Oftentimes, when the options expire, the expected gains do not materialize.  The reason is usually because option prices (implied volatilities, VIX, - for those of you who are more familiar with how options work) fall.   (The risk profile graph software assumes that implied volatilities will remain unchanged.).   Of course, there are many weeks when VIX rises and you might do better than the risk profile graph had projected.   But the bottom line is that there are times when the stock does exactly as you had hoped  and you still don’t make the gains you originally expected.

With all these negatives, is option investing worth the bother?  We think it is.  Where else is the chance of 100% annual gains a realistic possibility?  We believe that at least a small portion of many people’s investment portfolio should be in something that at least has the possibility of making extraordinary returns.

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for the past 4 years), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

Terry's Tips Stock Options Trading Blog

December 5, 2016

Comparing Calendar and Diagonal Spreads in an Earnings Play

Last week, in one of our Terry’s Tips portfolios, we placed calendar spreads with strikes about $5 above and below the stock price of ULTA which announced earnings after the close on Thursday. We closed out our spreads on Friday and celebrated a gain of 86% after commissions for the 4-day investment. It was a happy day.

This week, this portfolio will be making a similar investment in Broadcom (AVGO) which announces earnings on Thursday, December 8. I would like to tell you a little about these spreads and also answer the question of whether calendar or diagonal spreads might be better investments.

Terry

Comparing Calendar and Diagonal Spreads in an Earnings Play

Using last Friday’s closing option prices, below are the risk profile graphs for Broadcom (AVGO) for options that will expire Friday, December 9, the day after earnings are announced. Implied volatility for the 9Dec16 series is 68 compared to 35 for the 13Jan17 series (we selected the 13Jan17 series because IV was 3 less than it was for the 20Jan17 series). The graphs assume that IV for the 13Jan17 series will fall from 35 to 30 after the announcement. We believe that this is a reasonable expectation.

December 2, 2016

Update on Oil Trade (USO) Suggestion

On Monday, I reported on an oil options trade I had made in advance of OPEC’s meeting on Wednesday when they were hoping to reach an agreement to restrict production. The meeting took place and an agreement was apparently reached. The price of oil shot higher by as much as 8% and this trade ended up losing money. This is an update of what I expect to do going forward.

Terry

Update on Oil Trade (USO) Suggestion

Several subscribers have written in and asked what my plans might be with the oil spreads (USO) I made on Monday this week. When OPEC announced a deal to limit production, USO soared over a dollar and made the spreads at least temporarily unprofitable (the risk profile graph showed that a loss would result if USO moved higher than $11.10, and it is $11.40 before the open today). I believe these trades will ultimately prove to be most profitable, however.

November 29, 2016

Benefiting From the Current Uncertainty of Oil Supply

The price of oil is fluctuating all over the place because of the uncertainty of OPEC’s current effort to get a widespread agreement to restrict supply. This has resulted in unusually high short-term option prices for USO (the stock that mirrors the price of oil). I would like to share with you an options spread I made in my personal account today which I believe has an extremely high likelihood of success.

Terry

Benefiting From the Current Uncertainty of Oil Supply

I personally believe that the long-run price of oil is destined to be lower. The world is just making too much of it and electric cars are soon to be here (Tesla is gearing up to make 500,000 next year and nearly a million in two years). But in the short run, anything can happen.

Meanwhile, OPEC is . . .

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