The Writers Coin

Short answer: yes, there is a lot to learn when it comes to options.

Long answer: it’s not as hard as you think. Most people assume that options are too complicated for their little minds to grasp, so they don’t even try to. And the little bit they do they know is usually wrong.

Options are actually less risky that stocks. That’s right—I said it. But am I full of crap? I mean, so many more people trade stocks than options—why would novice investors use a tool that’s riskier than the less popular one?

Ignorance. People just don’t know.

My Experience with Options

I made my very first options trade last week, and I’m damn proud of it. I studied options for months (the book, Understanding Options, was invaluable—do check it out if you want to learn this stuff), traded them virtually, and asked people that knew much more than me to show me the ropes.

All that culminated in my first real trade last week, and now I can share some of what I’ve learned along the way to dispel the myths that are commonly associated with options.

Myth #1: They are too Risky

False: options allow you to make trades that eliminate a lot of the risk you face with stocks.

The way options work, you can cap your losses (and your wins) so you know exactly how much you’ll lose if the worst-case scenario happens. A stock can go all the way to zero and you lose all your investment. Options allow you to say “I am willing to cap my gains at X, but I also want to cap my losses at Y.”

Sure, you can set stop losses when trading stocks, but most people don’t do that because they don’t know when to sell. The allure of a stock bouncing back and shooting up is usually too high. With options, time is built in: expiration dates force you out (or in) of a position—no more worrying about when the “perfect” time to sell is.

Myth #2: I Need a LOT of Money

False: You don’t.

Sure, if you want to make a ton of money, you’ll have to have a lot in your account to execute some of the fancier positions out there. But because options allow you leverage very effectively, you can make more money that you could with that same amount of money in stocks.

Since one option contract represents 100 shares, minute gains turn to real nice ones pretty quickly…if you play your cards right.

Myth #3: They are Too Complicated for Me

Depends: How much do you want to learn it?

If stocks are like checkers, then options are like playing chess. You’re playing on the same board (the world of stocks) with different pieces (options vs. stocks) and with different rules.

But checkers is for kids and it’s kind of boring. If you can move up from checkers to chess, you can go from stocks to options.

There’s a good reason to make the move: options allow you to do make moves that are much more interesting. With stocks, you’re trading idea is that it will go up or down. You can buy a stock or sell it short.

Boooo-riiiinngggg.

With options, the choices are unlimited. Here are some of the things you can express with options:

• This company rocks, I want it to go up! But I don’t want to lose more than X.
• This company sucks, but in case it goes up, I want to be protected.
• This company is OK, but I think it’s going to stay below $40 for the next three months.
• I think this company is going up, but I don’t want to pay it’s current price to own the stock. So until it hits this lower price, I just want to take in some premium ($).
• I think this company is great, but I’m not positive it will go up. I think it will stay above X for the next month, and if it does I want to make money.

This is a smattering of the strategies you can put into place with options. Isn’t it more intellectually stimulating than “up or down”?

Interested?

I’m not sure if my readers (that’s you!) even care about options. So if you don’t, please let me know! But my short time with them have been a very good learning experience, and I’d love to share more of it with you.

They aren’t for everyone, but I like using them as a vehicle to express my short-term views on the market. For the long term, I’m covered with index funds.

And don’t forget about the comments section—you know I love me some comments!

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Image by Perpetualtourist2000

This post was included in the Money Hacks Carnival

OK, honestly? I’ve never run a marathon—but I am in training for the Urbanathlon (an eleven mile race with obstacles mixed in). And that means going on long runs that, most of the time, aren’t fun.

But running long distances has some unintended benefits—you learn a lot of things you can apply to totally unrelated parts of your life.

Don’t Stop

You’re going to want to stop—trust me. Because every part of your body hurts and you start asking yourself questions like “Why am I doing this?” But you have to keep going because once you stop, the odds of starting back up again are pretty low. And if you stop a bunch of times you’ll never finish.

Investing works the same way—that’s why making it automatic is so important. Make it so it happens without you even noticing it—that way it’ll make it harder for you to stop. Which you’ll want to because you want to buy a house, a new TV, etc. But don’t stop—just put your head down and keep on running.

Focus on What’s In Front of You

You’re going to be out there for a long time. A LONG time—and that can be pretty overwhelming. I know I’m in trouble when I’m five minutes into a run and I’m already thinking about heading back. That will make the run feel even longer. So I focus on the pavement in front of me and try to put all thoughts of the finish line out of my head—music helps.

What’s your ultimate investing goal? For me, it’s retirement—and that’s not going to happen any time soon. But saving all this money and telling myself that it’ll be worth it when I’m old and wrinkly is sort of depressing. So I just save the money, invest it as I see fit, and go about my life. And yes—music helps here too. This is why it helps to set goals along the way—they can give you a real sense of progress.

Don’t Forget it’s a Marathon

Just don’t forget you have a long ways to go. Focusing only on that sliver of pavement ahead of you can be dangerous because you might run out of gas before you finish the race. You have to pace yourself and leave enough in the tank so you’re in good shape to cross the finish line. I get a little excited sometimes when a great jam comes on and start going really fast. Then I get gassed and finish in pain.

Don’t get all excited about this and decide you’re going to save $3,000 this month to kick start your investing fund—these types of one-offs are unsustainable. Just like you can’t sprint through a marathon, you’ll never be able to “pump yourself up” with enough energy to pull this kind of stuff off. No way. You need to set a good, reasonable pace and stick to it.

Try Not to Compare Yourself to Others

When you’re out there training, you’ll see other runners blow by you and you’ll think to yourself, “I suck.” But you don’t know if they just got started, if they’re only running a couple of miles, or if they just robbed a bank. So comparing yourself to those around you is only going to get you in trouble—only you know your pace.

Someone will always save more than you, invest better than you, and wind up with more money than you. Maybe they had a trust fund, maybe they got lucky, or maybe they robbed a bank. You never know—so don’t try to figure it out. It’ll just drive you crazy.

Break Through the Pain

If I’m running 8–10 miles, I’ll usually hit a wall around mile 3. My body feels like it’s done and can’t go any further, and I start thinking that maybe something is wrong. How am I supposed to run for another five miles? But you push through that wall and find a well of endurance on the other side. It’s weird, but the sooner you get that out of the way, the smoother the run will go.

Starting is the tough part—we all know that. But stick with it long enough and you’ll see that it only gets easier and easier. Sure, the stock market might collapse again and you’ll lose a lot of your hard-earned money, but that’s just a part of investing.

If that happens, you can always go out and rob a bank.

For more on running and money, check out The Steve Prefontaine Guide to Getting Rich and Three Things Running Can Teach Us About Personal Finance.

Sweet image by Duncan Rawlinson

What’s the main reason any of us invest in stocks? Reward, right? It’s because:

The market, on average, will return 8% per year.

We’ve heard that so often that most of us just take it for granted. Sure, we’ll add caveats like “over the long term” or “around 8%,” but it’s a statement that holds true for most sensible investors. Why? Because history says so. Even with the huge dip stocks have just gone through, the S&P has returned right around 7% per year since 1950. On average, of course.

It’s shocking to me that so many of us buy into that 8% number. How do you reconcile that cliché with this one:

Past performance is not an indicator of future returns.

How many times have you heard that one? It’s in practically every single mutual-fund prospectus as a legal clause that protects the people selling it to you. Here’s basically what it’s saying:

Here, we’re going to show you how this fund has done in the past because we know you want to see it. You just can’t resist it—that’s just the way you wacky investors are. And we’re so sure that you’re going to give past returns so much weight that we’re going to throw in this line that says that past returns have absolutely nothing to do with what will happen in the future. Why? Well, because it’s true. But also because we want to cover our asses.

I know what the next step should be: I should tell myself that I’m investing in stocks because I can handle the added risk in exchange for the added reward. But I’m still having trouble reconciling these two thoughts in my head.

With that, I leave you with some F. Scott Fitzgerald:

The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.

I’m working on it…

Last week I caught an article on Yahoo Finance titled Seven Ways to Simplify Your Investment Life. My favorite tip was #5: Jot Down Why You Own Each Investment.

When it comes to picking individual stocks, I love hearing the “why” behind a specific choice. I like hearing these rationalizations and the thinking that went before the trigger was pulled. Writing them down creates a little time capsule that you can’t argue with: that’s why you bought it at the time. If you don’t write it down, you can always change your story.

Being a writer, I can appreciate the value of writing things down—it’s a great way of reminding yourself of why you did something and thinking an idea through a little bit. And I’m not alone here—other bloggers also know the power of writing things down.

The Mock Portfolio

I used to have a Word document that I used as a paper-trading terminal. If I saw a stock I was interested in, I’d “buy” it by entering the date, the price, and the ticker symbol in the document. And then came the important part: the reason why I was buying it. Sometimes it was as simple as “read an article about it.” Other times, it was far nuanced. Stuff like “if things keep going the way they’re going, this company should hypothetically see an uptick in customers.”

Justifying the picks had a very interesting effect on my pretend investing—I felt like I had to have a good enough reason to virtually buy them. I had to answer to the mock portfolio for all these fake decisions.

Going back to check out the picks from my mock portfolio was fun back when the whole market wasn’t down on its knees begging for forgiveness. And taking a look back now is pretty interesting because most of my picks are underwater. Except for Goldcorp (GG), which I bought because:

Read about the CEO, had a competition to see who could find more gold, an open source type deal, pretty cool, was very successful. They’ve been acquiring left and right. It’s a commodity and they’re in Canada. But whatever, I’m in at 27.18.

That was back in January of ’07. Today, the stock is at $32.

But the most interesting entry to look back on is the very last one I ever wrote:

May 16, 2007
Watch List: BAC, C, JNJ, and PG
All this talk of impending doom makes me want to get ready. These are proven stocks, winners. All have a dividend too (for the Roth). So if and when this goes down, I’ll put my money into these companies when the downturn forces them down. Then I’ll hold them for the long run, obviously. I may have to pick one from BAC (MOS is less than half, not as good as C) and C (MOS is half of actual price) and another from JNJ (around half) and PG (actually pretty close, best one), since they are in similar industries. (spreadsheet numbers)

This is where the value of writing things down becomes obvious: it’s hard to think back on what we were all feeling in 2007, but it’s pretty clear there was some unease in the market. Investors were scared that something really bad was coming. They were right, and it looks like I was partially right too. The banks got killed but so did stalwart companies like JNJ and PG, which are now trading at a “discount” from their 2007 price.

It looks like it’s time to fire up the ol’ mock portfolio again and see what JNJ and PG can do for me in the future.

Photo by Star Dust