Retail Investing: Short Term Concerns for Long Term Options Investing

Recently I presented the OICs (Options Industry Council) newest options seminar, Options Fundamentals. Options Fundamentals is part one OICs new three part series developed with retail investors in mind. This three part series is presented over three months with each section being presented one month after the previous section. Next month will be Trading and Understanding Risk and the last in the series is Option Trade Management.

Options Fundamentals covers the components of an option contract, the rights of option holders and the obligations of short option positions as well as some basic strategies such as buying calls and buying puts. I’ve been teaching options for the OIC for over 10 years now and have been in the options business since 1982. I’ve spent my career on the retail side of the business talking to and learning from Account Executives, Financial Advisors and Registered Reps for firms across the country. I’ve never traded firm money or made markets on the floor, I’ve always dealt with investors and their Registered Rep. – a role that I’ve always found enlightening and rewarding.

As the years passed, I’ve noticed large numbers of individual investors taking greater responsibility for their investments and taking a more active role in their financial futures. Many are turning to options, they have found that options are very flexible and offer solutions to short term concerns that long term investors come across from time to time. Many times investors are concerned about earnings or a new product release. This concern is short term, the investor believes in the company and may have owned the stock for years, but they may be concerned about a short-term event like bad earnings or a delayed product release. The thought process begins:

What if the stock drops? What if the stock really drops? Should I sell, should I tough it out?

Here is where the protective put helps. The protective put acts like an insurance policy by establishing a short term (may be long term if a LEAP is used) possible selling price for the stock should something potentially negative occur. Sure you pay a premium for the policy and if the nothing bad happens you will lose that premium, but if it does, that protection can help minimize any loss. It is really no different than car or home insurance in many ways. Every six months I pay Joes All Star Insurance for collision and theft coverage for 2 cars and so far I haven’t collected, but I sleep better at night. The protective put acts the same way. The protection is there if you need it, but you’re happy when you don’t.

Another option strategy employed by long-term investors is the covered-write. Many times investors buy stocks hoping for a rise in the price but don’t see the rise they were expecting. Again, they believe in the stock, but could use a little additional income (can’t we all!).

Here’s where the covered-write may help. The investor can sell a call. Now a short call is an obligation to sell stock at a certain price within a certain period of time, so this position limits upside potential. However, in exchange for giving up that upside potential the investor receives a premium. That premium is his to keep no matter what happens to the stock. If the stock does not rise above the price before the options expiration date, the option expires worthless and the investor keeps the premium. If the stock falls, the investor still keeps the premium. If the stock rises high enough, the investor will be obligated to sell his shares. There are actions the investor can take to avoid selling the stock, this falls into trade management.

Trade management you ask? Do you like to buy and hold? Set it and forget it? If you prefer to set it and forget it then options may not be for you. Options require time, effort and some maintenance. You must be aware of stock movements and option movements; you must understand what happens if the stock goes up or goes down and what happens as time passes – all of which impact your investment.

Not every option strategy works in every situation, but they work in some situations that may apply to your needs. The flexibility offered to both short term, and long term investors is not found in any other financial product.

Once again they do require time and effort, but it’s your money and your financial future, isn’t that worth it?

Used properly options can help control risk, generate income or speculate on stock movements. Remember, options involve risk and are not for everyone. Be sure to know and understand the risks and rewards of any option strategy before entering into that strategy.