Option Trading Myths Exposed

09/06/2011 9:25 am EST

Focus: OPTIONS

Kerry Given, PhD

Founder and Managing Director, Parkwood Capital LLC

Don’t get duped by the "get rich quick" crowd that touts options as a sure-fire ticket to success, warns Kerry Given, reviewing what it really takes to achieve success and longevity.

Exploring the myths of options trading today with Kerry Given.  Hi Kerry. Lots of myths are out there surrounding options trading. Can you tell me some of them?

Yeah, unfortunately, there is a lot of sales and marketing hype. For example, I just recently got an e-mail advertising a course, and the e-mail had a headline that said "How to find high-probability trades where the rewards are about three times what you risk." 

Sounds too good to be true.

It is, absolutely. The reality is if you study options trading, the high-probability trades where you have a low possible gain, but you have a large maximum loss. It has a low probability of occurring, but it’s a large loss.

So that means a trade that has a gain of three times what my maximum loss is, by nature is a low-probability trade, and so the idea of having high-probability trades with a large gain, that’s impossible.

Just not going to happen. What are some other myths?

Another one that I was actually taught early on in my own training was that when volatility is high, you should sell credit spreads, and that just simply isn’t true. 

You can prove this to yourself by going to an options chain and simply setting up a trade at two strike prices—say, a bull put spread—and then at the same strike prices, set up the bull call spread, and you will see that the returns are identical.

Is it because options are so arcane that you have so many myths surrounding them?

I think that’s part of it. Sometimes people don’t understand the underlying math and probabilities. Other times, it’s simply because people are trying to sell a particular service or product, and some of these myths do sell.

How do we insulate ourselves against these myths?

I think the most important thing is just what you said earlier. If it sounds like it’s too good to be true, then you need to investigate very closely, because it probably is. 

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