10 Red Flags to Watch in an Options Alert Service

01/10/2014 8:00 am EST

Focus: OPTIONS

If you currently subscribe to an option trading alert service, or if you’re considering doing so, here are some telltale signs to look out for, says Greg Loehr of OptionsBuzz.com.

1. The service doesn’t have any losing trades. Or doesn’t have very many. Losing on a trade is a natural part of trading options, and if someone doesn’t have any losing trades, that probably means they’re just hiding them from you. Or it could be that all they’re doing is selling put spreads on the SPX that are far out of the money. Eventually, those kinds of trades will blow up in your face.

2. The service won’t show you their closed trades. If you aren’t allowed to see all of the previous trade alerts that they’ve created, then what are they hiding? The service should stand behind all of their trades, both the winners and the losers.

3. The trades have huge risk. Beware of option trades that sell options naked, which means selling the option by itself which gives the trader huge risk. It may look like easy money, but eventually you’ll get burned very badly doing this.

4. The service inflates their ROI numbers. Profits and losses should be calculated against the risk in the trade—not the per share cost of the trade. Using the cost of the trade to figure the return can dramatically inflate the ROI and show returns that wouldn’t pass even the most rudimentary accounting standards.

5. Uses language like “bull call spread” or “bull put spread.” That language was created by the option trading seminar industry for the purpose of confusing the students and then selling them into the next $3,000 class to clear up the confusion. If the person running your trade alert service uses this language, then he most likely learned to trade from a seminar company rather than from a professional trading firm.

6. In-the-money call spreads. If you’re ever shown a trade that’s buying an in-the-money call spread, then 99% of the time the person showing you that trade doesn’t really understand options. Selling the put spread with the same strikes as the call spread is synthetically the same trade in every respect, but it probably gives you a better entry price.

7. Selling credit spreads gives you your money up front. There’s no opening trade that gives you money up front. When you trade a credit spread, you’re actually reducing your option buying power in just the same way that your option buying power is reduced when you trade a debit spread. Again, this is a sign that your trading service doesn’t really understand how options work.

8. Worried about assignment. If your service ever mentions that being assigned on a short option prior to expiration is a bad thing, run in the other direction. Assignment doesn’t increase your risk or cause you to lose money (other than a commission), but can actually give you more profit. Why doesn’t your trading service understand this?

9. Doesn’t give you a trade plan. Every trade should have a detailed exit plan in place before the trade is entered. That’s just standard operating procedure.

10. Only trades a bullish market. The idea that the market goes up over time is false. All companies eventually go out of business, or are bought out. The indexes go up over time because they are manipulated, but individual stocks don’t always go up. Just look at a chart of GM. So if your service can’t trade in sideways or down markets, then they’re really just a one-trick pony that’s going to miss a lot of the opportunity in the market.

By Greg Loehr of OptionsBuzz.com

Related Articles on OPTIONS