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Dear Fix My Portfolio,
MarketWatch recently posted about a day-trading strategy that produces a 46% annual return. I have been trading options for over 11 years. My strategy has achieved over 90% net annual return for years. I have not lost a trade in over five years. I do not day trade. I simply enter trades once per month with 20- to 30-day time durations. I’m 86 and a founder and CEO of several companies. Any suggestions for how to monetize my options strategy?
-Jim
Dear Jim,
That article on the strategy for a 46% return piqued a lot of interest, but the real message of the article was in the first sentence: “Day trading, for most people, is a disaster.”
So too, options trading. We have noted in other articles that options trading increased more than 224% from 2019 to 2021 and resulted in more than $1.1 billion in losses. Good for you if you’ve found a way to make it work, but for most people it will eventually end up a losing proposition. And just because you’ve made money in the past, the old adage applies: Past performance is no guarantee of future results.
So the quick answer to your question is that monetizing your strategy beyond your own trades is unlikely. It’s great that you’ve had a string of success over the past five years, but that’s unique to your own financial situation. You could consider writing a book if you think your experiences would generate interest, but you don’t want to get caught up hawking get-rich-quick schemes to others who might not have the same economic situation as you, or who might not have the same level of financial education. A 25-year-old with little investing experience can’t use the same strategy you employ at 86 with a lot of knowledge. Your goals and risk tolerance simply aren’t comparable.
Studying needed
Before anyone starts trading options, they need to assess their situation and decide what’s comfortable for their financial situation. “It becomes very real for people when money is involved,” says Gina DeRaimo, head of the Options Institute at Cboe, an options exchange based in Chicago.
The first thing to master is the lingo. Options are derivative contracts between a buyer and a seller for a specific duration and price based on the value of an underlying stock. “Calls” are contracts that give the buyer the right (but not the obligation) to buy a stock, while “puts” are contracts that give the right (but not the obligation) to sell. You essentially bet as to whether you think the stock price is going to go up or down, and by how much, by taking one side of the trade or the other. The positions have different amounts of risk and many people hedge with combinations (saddles, spreads, etc.). If you want to dive in, the Cboe has resources available, and you can also follow the latest news on MarketWatch’s options section.
“You need to understand how puts and calls work separately, and what the zero-sum game is over the trades,” says DeRaimo. “Then you build an understanding of when you combine trades together.”
How much risk can you handle?
If you’re not day trading, you’re being somewhat cautious. It’s also likely that you’re just trading a portion of your nest egg (one would hope), rather than putting the whole thing on the line. For retirees who have a lot of stock in their portfolios that they don’t want to sell but want to leverage in some way, the least risk you can take with options is to write covered calls. That means you sell a contract for somebody else to buy a stock you already own at a certain strike price, for a specified premium.
Both your maximum loss and gain are limited, and if the option expires without being exercised, then you get to pocket the premium. On the other end of the risk spectrum, you can trade short call options, which means you don’t own the underlying stock, and end up with potentially unlimited loss.
“It can be overwhelming, which is why we like to make sure all the language and concepts are understood,” says DeRaimo.
The best way to see how you’re doing, whether you’re a beginner or trying to test to see if your strategy is a sure thing, is to run simulations before you trade real dollars. DeRaimo says she encourages everyone to use the tools available at their chosen retail options broker or free tools online.
“Running backtests on our decision-making process is something the professional community does quite often. The tools available are phenomenal,” says DeRaimo.
If you want to get a detailed assessment of how good your strategy is, you’d want to talk to a financial adviser who has a specialty in options trading. They can walk through your actual numbers and the choices you made versus the ones you could have made.
That still, however, won’t tell you what decisions to make going forward, which is why you need so much caution when dealing with options strategy. You’re designing a plan based on whether you think the market is going up or down, which can change in a flash. You need to be very aware of current market conditions and shift your actions as things change. That can make backtesting very tricky.
“Models and scenario-testing can show us where some guardrails are, but we can’t pretend those models are reality,” says DeRaimo. “The only thing we can guarantee is that there’s uncertainty.”
April is National Financial Literacy Month. To mark the occasion, MarketWatch will publish a series of “Financial Fitness” articles to help readers improve their fiscal health, and offer advice on how to save, invest and spend their money wisely. Read more here.
