Conservative vs. Risky Option Strategies
03/21/2014 9:05 am EST
Option expert Michael Thomsett talks about conservative option strategies, as well as what he considers as the riskiest option strategy that traders should avoid.
SPEAKER 1: I’m here with Michael Thomsett talking about options strategies, and Michael when you first told me you wrote a book about conservative options trading I thought that’s an entire book. Tell me more about it.
MICHAEL: That’s exactly what my publisher said. He said how long a book can you write about covered calls, and I said that’s just the starting point. There are a lot of additional trades that are conservative and I did outline for him and demonstrated that in fact there was more there than I thought. There are a lot of ways options can be used conservatively.
SPEAKER 1: Give me an example of a way that a trader thinking about trading options can have a conservative approach that isn’t the same old covered call.
MICHAEL: Alright. For example, let’s say that you’re a stock owner and your stock has declined in value and you’re thinking well should I sell now and take my losses and get out of this or if you expect it to go back up, one way to double-up on that return to zero is to now buy calls, or sell puts at that point if you’re pretty sure that it’s going to return to the higher, buying calls and selling puts will double your profit by you’ll make it in the stock and the option. That’s one very simple example. Same thing happens when the stock rises, and this is even more important. When the stock rises we get scared because we’re thinking do I sell now and take my profits, which I don’t really want to do, but I don’t want to lose these profits. One way to keep the stock but still take the profits is to buy puts or sell a covered call at that point because if the covered call gets exercised and your strike is much higher than your basis, then being exercised is not so bad.
SPEAKER 1: So that’s fun and I like it and I’m interested in conservative options strategies, but I’d like to ask you a question that’s been on my mind. What’s like the riskiest possible options strategy that traders should avoid?
MICHAEL: Short straddles.
SPEAKER 1: Tell me about that.
MICHAEL: A straddle of course is where you open a put and a call at the same time and the same strike. The trouble with the short straddle is that one of them is always going to be in the money, so you’re going to have to close one side of the profit and either roll the other side forward or hope that the time value exceeds the intrinsic value and that does not always happen, so what you end up doing with a short straddle is you have to put up twice the collateral you normally would because you have two short positions and then you also have to hope that you can get out of those positions before they get exercised and if you have an ex-dividend date coming up and the calls in the money, chances are you’ll get exercised. So, someone who rushes a short straddle is hoping to make a bunch of money off the options, they might suddenly find that they’re stuck with appreciated stock.
SPEAKER 1: Michael, it’s been a thrill for me to talk about conservative and risky options strategies. Thank you very much.
MICHAEL: Thank you.
SPEAKER 1: You’re watching the Money Show Video Network.