Why Stock Options?

My name is Brian Quigley, and I am an experienced Options trader living in Chicago. I first learned about Options quite by accident while at Barnes & Noble when a book (creatively entitled, OPTIONS) caught my eye. A few pages into it, I found what seemed to me to be the Options Bible. With this innocent, yet exciting, purchase, an amazing door was opened to me. I felt I found a buried passion of mine in this book. It opened up a whole new world to me. I wish I knew about Options much earlier in life, but I do feel lucky to have stumbled upon them nonetheless, even if it wasn't until my mid 30's. I had no real guidance or a tutor. I just took in everything and anything I could absorb and understand about options. I made some mistakes, but nothing major. This is to be expected. I am financially conservative by nature and very analytical. These two characteristics helped me tremendously because I quickly found so many scams all over the internet. My BS radar was always on high alert - so many "gurus" wanting huge sums of money to help the naive become rich trading options. I went the solo route and just went at my pace and really tried to understand all the components to trading, the market, risk and Options. I wanted to survive this early phase of option trading. There is a lot that needs to be taken in to get the whole process but I was up for the challenge. I survived the initial phase of being a beginner and not losing all my money. Why? Because I recognized early that the market is not here for me. It is not an ATM machine guaranteed to fill my pockets. The markets are viscous, and have no morals or feelings. The market does what the market does. The market doesn't care who it crushes. The sooner investors realize this, the better they will be equipped to attempt to go into this vast, yet exciting world of options. I hope I didn't scare anyone away, but I need to be as honest and upfront as possible about the risks and realities. Whatever one's motivation is to enter the world of options, a very important question needs to be asked and answered for those who do want to learn how to use options...Why Options?

My first post on Options is to answer this basic question: Why Options? There are many reasons people use options, but many - IMHO - are misguided. If I were to advise anyone attempting to learn about options, the first question that needs to be answered is why? Most don't really know except they see the allure. They see the sexy side of the market and the flashy winners. They see the 1/1000 lucky options traders who hit it big on a trade. They don't see all the losing accounts at the various brokerage houses throughout the world. If you want to get into options and use them as a get-rich-quick scheme, then forget about it. The market will eat you alive. Save your money and put it into dividend-paying stocks, walk away, let the dividends re-invest and then check back in 30 years. You will be satisfied to still have all your fingers and toes and some money left over for your retirement.

LEVERAGE

However, if you have discipline and are humble to the market gods, then let's look at the main reason Options should be a consideration for you. In a word...LEVERAGE. Options allow investors to have opinions using far less capital than owning stock outright. By not tying up all their capital in a stock, investors can use far less less capital for the same opinion. And let's face it, every stock purchase is basically an opinion, nothing more, nothing less. The problem is, these opinions cost a lot of money.

Take MSFT for example. Today it is trading at $136.13 per share. To buy 100 shares an investor needs $13,613. In my opinion, that's an expensive opinion. However I can buy an option to control those same 100 shares for far less money. If I want to buy a 1-year option on MSFT today, I would only need to spend about $1,500. That is far less than $13,613. It's actually only 11% of the money needed to buy 100 shares outright.

SAFETY and DIVERSIFICATION

Another way of looking at using options is to calculate the actual amount of capital exposed to the whims of the market for that opinion. Assume 2 traders each have $20K accounts. The trader who actually buys 100 shares of MSFT has to commit $13,613 to the market, while the trader who uses options only needs to expose $1500 to the market, thus leaving the rest of the capital in a safer vehicle or another investment opinion.

The most the options trader can ever lose on our MSFT trade is the cost of the option: in this case, $1500. Owning the stock could actually produce far greater losses. Some stocks can actually go to ZERO! So, suddenly, an opinion which uses options uses less capital and keeps more capital in safer accounts that are less exposed to the whims of the market. This makes options far less risky. This leaves more capital to diversify and for additional opinions, should any arise. Many advisers believe diversification is paramount to long-term investing and surviving major corrections that inevitably do occur.

SEXY RETURNS

One other advantage of options besides safety and leverage is the far greater % returns the options trader receives compared to the owner of the stock. I have made most of my money investing using options. No way I could have made near the same amount of money if I was using a pure stock ownership strategy. I actually waiver on this point because I am so knowledgeable about options. Sometimes I see no point in paying to own MSFT. Sure, if someone wants to "donate" shares to me, by all means I will gladly take them. However, paying to own shares outright is extremely capital intensive and inefficient given my limited resources, and many other investors as well. Stock ownership seems best suited for mutual funds, the great spenders of other people's money. IMO, the way to real sexy growth in owning stocks comes if a trader can get in on the ground floor of stocks like AMZN, AAPL, NFLX etc long before they become household names. This is where the easy money and real wealth can be made. If traders miss those opportunities and still want to participate in any upside left in those names, OPTIONS are by far the best and most efficient way to invest in these companies without committing too much capital.

Don't Be Shut Out

If it takes $13K for just one opinion, then investors without deep pockets will be shut out of the investing game. Without the "leverage" and use of options, most investors will not be allowed to have many opinions. Having leverage and more capital allows for more wealth building, more safety and more diversification. These imo are powerful and justifiable reasons to consider options.

Heed My Warning

Here's my warning advice...too many new traders use options as if they are at a casino or at the track. Experienced traders LOVE these newbies because every time the newbies lose and blow out their accounts, a "donation" is being made to the market gods (the ones with the gray hair indicating they know how to play and remain in the game as a career). Think of these donations as "tuition" payments to the market gods. Please learn to use options as the smart folk do. Warren Buffet goes to town using options as do many mutual fund managers. I just want everyone to know that options can be a powerful tool in their investing arsenal, but new traders have to really be cautious and learn as much as possible so they can stay in the game long enough to survive and become one of the market gods. It takes time to learn a new craft. Trust me, options are amazing but a bit complex, so there is a learning curve. Take your time. Trade small. Be humble and trade at least a little scared. See how options behave, and see how you react to losses and wins. Never invest too much on any single trade.

Conclusion

I hope this introduction as to the "why" trade options was valuable, and you can now see the benefits options offer such as, safety, diversification, great returns and leverage. These benefits alone should be enough for investors to justify wanting to embark on this journey. There are many strategies that can be employed using options, which we will get into later. Today I just wanted to make sure new investors could answer the basic question, "why options" before taking the plunge. Once answered, traders will be free to gravitate to a few strategies and become experts in them. Next time, I will walk through an example of two traders and compare their returns on the same opinion: one using stock ownership and one using options. The results will be astounding!

I know this was long but - again, IMO - necessary. I promise future posts will not be as long.

Contact me at brian@brianquigleyinsurance.com if you have any questions.

Have you ever considered adding Stock Options to your investment arsenal?