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| Q & A | ||||||
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Q&A with The Optionist, Lynn Carpenter From the Journal of American Finance March 11, 2004 What’s the deal with options? Oh boy, they are hot. Dot-com, tech investing circa 1998 hot, some people say. I’ve seen the interest explode. In 1999, I worked for a large financial publisher and only one other person—a commodities trader—was doing options. Since then, almost everyone who ever wrote a single stock story has gotten in the game. Ready or not! Why? Where else can you watch a stock go up 3% and collect a 50% gain in a week? Where else do you make a series of trades on a bad idea for pennies down and collect more than the short-sellers, as I did with Enron, a 219% total in six weeks or so. But this isn’t really a dot-com situation. It’s the takeoff of a relatively new market. Options have only been available to us since 1972. For the first two decades, about the only people paying attention were big money managers. Some of this interest is just the blossoming of growth that’s been building. It reached the tipping point, where options became familiar. It won’t stay exactly like this. A lot of people in the game will fold. A lot of options letters and services are going to die. They’re cashing in on a craze, not really working hard enough. But as for people… that interest is going to stay. If the market goes into a flat line, for instance, as it did through the whole 1970s, options will be the only way to make money steadily and quickly. You can take on any market, bullish, bearish or sideways with options. Who can trade options? There are two parts to that answer, and the most important is “those who have the right psychology.” The second part is “those who have the means.” The second is important, but the first is life or death. Man, if you have trouble breathing when your mutual funds drop a point, please take my advice and avoid options trading. Run away. Please. Don’t let anyone with any claims of a perfect system talk you into it. There are no perfect systems, only good ones and bad ones. If you remain curious but you’re not the calm type, keep reading about options. Do some serious and consistent paper trading… do it every day or every week… and keep score. Tomorrow you may be ready. So a person can learn to be an options trader? Anyone? Absolutely. Anyone capable of buying stocks can learn options. They may sound confusing, but I’ve started hundreds of people with the basics and seen them ready to go in a week or two. The psychology, though… that’s different. It may take longer, and some people will never enjoy the reality of options trading. But it can be learned, too, if the motivation is there. Few options traders are born to the craft, few of the successful ones started there. Most of us learn it later. Much later. I remained a conservative and long-term oriented investor for many, many years before I began trading options. It was a long time before I was psychologically ready for all that excitement! In fact, you should feel very confident of your perceptiveness as an investor to do well with options. What is the mindset of the successful options trader? A few years ago, I might have answered this differently. But for the past five years, I had the pleasure of working with hundreds of investors who wanted to trade options. Some were very experienced, some brand new. They literally showed me the difference between the winning mindset and the losing mindset in real time. And, although, it’s necessary to know your basics, knowing tons about options—spouting off about deltas, thetas, iron butterflies and such—this kind knowledge is not the magic key. The most amazing thing I observed when working with my traders was that, given exactly the same recommendations, Dear Old Joe would make a fortune, while Poor John Next Door would lose one. Later, I talked to a lot of seasoned full-service brokers, money managers and investment advisors about this. They confirmed my observation. It is a broad phenomenon that everyone in the business of handling money or advising investors experiences. They don’t talk about it in public… so I’m revealing a deep trade secret here! It didn’t matter if all the trades were winners on my books. Some people will succeed and some will lose. They’ll find a way to lose against almost impossible odds! I began studying investor psychology and listening to my readers to learn how they differed. It’s black and white, the differences. The biggest one I noticed is that the successful trader has lower expectations, reasonable ones. The guy who’s going to lose no matter what has huge, crazy expectations, unrealistic ones that no pro would ever entertain—he’s fully expecting every trade to be an easy and fast home run. There are other big differences. What are they? Can you give us a checklist of what good options traders have going for them? You bet I can. Here it is for options traders: Enough money, enough nerve, planning each trade from beginning to end at the outset, endurance, taking personal responsibility, understanding odds and probabilities and having a real system. You have to have a whole system. Can you expand? What do you mean by enough money and enough nerve? Ok, here you go…
What about the planning part?
Bad traders get fired up counting profits and charge in before they think. The good traders also evaluate the risk and they won’t take any trade, even one they think is really exciting, unless the reward to risk is way in their favor. 2 to 1 or higher, most of them. For day traders, which I’m not, the ratio can be closer, 1.4 to 1 even because they trade so frequently. But the good traders always know ahead of time what they’ll do if the trade goes the wrong way, where they should exit. On top of this, of course, you have to set a target then choose the best strike price and expiration date. That varies for every trade. I set them in my service, but all traders who succeed have a strategy for choosing the best option of all the choices. What do you mean by personal responsibility? Let me see if I can put it another way. Big shoulders, yeah, big, big shoulders…
I’ve communicated with a lot of people who trade options. Everybody loses a trade now and then in options. The guys who have been doing it for years and making money are amazing people. I’d want them on my side in a bomb shelter. They have the ability to keep their focus forward and accept the bad results as intelligently as they take the good ones. Some of the best traders I know even laugh at themselves when they do something stupid, like going on vacation with settling up… being out on the golf course when it was time to get out, then missing the profits. They’re good people, not whiners. The good traders don’t waste a minute of their lives blaming Alan Greenspan, the traffic, evil analysts, or having to wait too long at the dentist for why they missed a trade. They are very competent people. Many of them have demanding full-time jobs, and you might say they “don’t have enough time” to spare. But they do… they make it. They manage it. It’s important to understand odds? Why is that? You bet it’s important. Knowing how odds, probabilities work… what the words really mean and don’t mean gives you the tools to set up your trade and take only the right trades…
If you throw a penny, you have a 50-50 chance of heads. If you throw it 100 times, every chance it still 50-50. The penny has no memory. It doesn’t know you just threw 20 heads in a row and you’re “due” for tails. Many options players don’t know this. They double up when they’ve been losing because they think they’re due. Might as well put a “rob me” sign on your chest. The other corollary to this is that the odds control what you do, how you handle a trade… or they should. They also mean that a system that is 65% accurate is also wrong 35% of the time. So you plan a strategy that is profitable if you are wrong 35% of them time. Bad traders are completely amazed when that 35% comes to pass. The last one was strategy, wasn’t it? What about strategy for options traders? Is there a special right system, a way you should always take profits, for instance? There are many systems. Several of them work. The important thing is to have a system, one that fits the tools you are using and your temperament, not bouncing from idea to idea randomly. I’d call it the overall strategy to put it more accurately…
It’s like playing baseball at the highest level. So you win game 1 of the World Series? Big deal. Nice start. But you aren’t champ unless you win four out of seven games. Period. You cannot, absolutely cannot, succeed at options unless you have a whole strategy that works. There are many, but you have to follow one… a rule for when to enter, what signals or information you follow, risk-reward minimums, expected success rate, where to take profits, when to exit, how much money to put on each trade… That sounds hard… so very few people are suited to options, right? Wrong. Dead wrong. Lots of people aren’t ready for options when they jump in, that’s all. And most of them don’t have someone there to help them with the mental part of the game. They get a lot of blather about what kind of order to put in, which technical indicators to use, back testing, charts, four-part hedging strategies, or the big bucks. But they don’t get much help with understanding the mental strategy of options… how you do it. Yet I’ve found that nearly all the people who show interest are smart people, definitely smart enough. They know how to manage a business or handle their money. If you tell them winning at options is like winning the World Series, they get it. I think almost anyone can learn to trade options successfully if someone shows them all this. Shares the real secrets. Whether they want to after they learn the real rules of the game is another story. Most do, at least to dabble with a bit of money. It’s the only real excitement left in the market right now. How much money? Oh, we could go on and on. I have information on that… how much money you need on my website. Along with a self-test, an introduction to option basics, technical systems and lots of other information on my website. Whether people choose to use my service, someone else’s or nobody’s, I’d like everyone to know these things. A former boss of mine used to lecture me month after month when we talked that I was supposed to be selling secrets “Nobody wants to know all that crap, Lynn.” He’d say. “They want you to do it and surprise them. Just tell them what to buy.” We’d go through this conversation over and over, and I’d continue teaching. Finally, he saw the numbers and gave up. “I don’t understand it, but your little teaching things are working. Keep it up.” Teaching, sharing information—OK, call it spouting off—that’s part of my personality. I can’t help myself. So I give a lot away. There’s a lot on my website even for people who don’t subscribe to my service. Besides, we investors have to stick together. You’ll share your secrets? You don’t hold anything back? Sure I do. OK, there are one or two proprietary things in my system that I haven’t written about. Maybe I will someday. It’s more that I haven’t found an easy explanation for some of the calculations I make in my head based on experience. Some day, I’d like to do an intensive seminar on some of that. But heck, yes. I’ve been giving my investment secrets away for years… that’s why my subscribers keep coming back. The more they learn from me, the more loyal they are. Even if you know my whole system, somebody still has to do a heck of a lot of work. That’s me. I don’t sell secrets… I sell my work. So what’s that address, again? www.theoptionist.com. Just like The Shootist. My husband came up with that name because I’m a big John Wayne fan. I love it. Thanks, Lynn Hey, I thank you for letting me talk about a subject I love. |