Debunking Option Myths

03/25/2014 9:33 am EST

Focus: OPTIONS

Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

Technician and option expert Greg Harmon clears up a few common misconceptions about options that have made it into conventional wisdom over the years.

SPEAKER:  I'm here with Greg Harmon talking about myths and rumors that we hear about options.  I heard the other day someone tell me, "The only way to make money trading options is to sell for premium."  Is that a myth?  Is it partially true?  What's the story, Greg? 

GREG:  I'll go with it's partially true.  You can make money selling premium.  Covered calls are a good way to do it.  You've already got a position in the stock then, so your risk is really just capping your upside, but I would also add that selling premium could get you in a whole heap of trouble, too.  Selling downside puts, you think they're out of the money, you're going to collect a premium, and all of a sudden, your stock drops $20, and you put the stock, and it's worth a quarter of what you had thought you were going to have to pay for it. 

SPEAKER:  You said "selling a downside put."  Can you describe that situation to me? 

GREG:  Sure.  So, Tesla stock's trading about $200 now.  Some people would say, "Well, it's never going to drop $20 in a day.  I'll sell the February 180 puts, $20 out of the money."  Then all of a sudden there's some correction going on in the market or another car comes on fire, and the stock's down at $160, and all of a sudden you're puts that you sold for $1.50 are $20 against you.  You don’t ever want to be in that situation, either.  It's not as simple as saying that selling premium is an easy, riskless strategy.  It's not riskless. 

SPEAKER:  Might a strategy to sell for premium make sense? 

GREG:  Well, there are a couple places.  I talked earlier about covered calls, so that's increasing income on positions that you already have an interest in owning and maybe capping your upside, or maybe not.  The second is if you want to get into a stock at a lower price.  That Tesla example:  If you wanted to buy Tesla at $180 but it's at $200 today, selling the $180 put so that if it falls down to $180, you end up buying the stock at $180; it's not a bad entry point. 

SPEAKER:  That's great information.  Thanks, Greg. 

GREG:  Thank you. 

SPEAKER:  You're watching the MoneyShow.com video network. 

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