Message Font: Serif | Sans-Serif
No. of Recommendations: 36

I've been a Fool for about a year and I can truly say that I agree with the majority of ideas advocated by Fooldom. However there is an area where I think TMF is shortchanging its readers: Options.

Every article I have read at his site (regarding options) tries its best to discourage readers from using options as part of their investment strategies. As far as the TMF is concerned, options are strictly speculative tactics for day traders and gamblers. Well, it is TRUE that a large number of option players are pure speculators and many of them loose big $$ gambling with the daily ups and downs of the market…….BUT…the World of Options encompasses a much bigger picture. After spending several weeks studying options at the CBOE site and reading 3 unbiased books on options I would like to share the following remarks:

TMF seems to believe that options means buying near-term Calls. This practice is mostly done by speculators, but there is a lot more to options than that. Let me give you 3 examples:

1) I could be a VERY CONSERVATIVE investor and still use options as an strategy to accomplish my goals. Example: An investor already own 100 shares of AOL (bough them on 6/1/98 at 20) today it trades at 135, but he is nervous about Y2K so he buys a Put where he pays $450 and it guarantees a price of $120 for his shares (JAN 120 put at 4.5). For a mere $450 he has bough peace of mind. If AOL tanks he will sell at 120 and takes home a nice profit of 10,000 (120-20). If Y2K goes smooth, he keeps his shares and takes a $450 loss. You say, wait a minute, place a sell stop order at 120 and you accomplish the same, well…yeah…but the Put gives the investor CHOICE. He can determine the reason for the stock price fall. It could have been a blip, the market got scared, AOL went below 120 for a few hours (or days) but there was nothing seriously wrong. The company model is still intact, its computer systems are OK, the price is already coming back. So he chooses not to exercise the Put and keeps his stock. On the other hand the stop order would have executed leaving the investor the victim of a market panic (in other words no control, he couldn't make his own decision). If the market really collapses, AOL is now trading at 60 and things are looking bleak for the whole economy, then the investor can sell his shares at 120 for a 10,000 profit. By the way this Y2K example is somewhat dramatic but it clearly illustrates the value of hedging with puts

2) I could be an EDUCATED, VALUE ORIENTED investor and still use options as an strategy to accomplish my goals. Example: An investor notices that a blue chip company (WMI) has taken a huge hit on its stock. In the last 3 months it went form 50 to 18. He proceeds to research the company and he after evaluating the company financial data he believes that the company will be OK in the long term. After some investigation he also conclude that the new management team will take care of past problems. Conclusion: BUYING OPPORTUNITY (maybe he is right maybe not, but he has done his homework and he thinks it is a buy). He could buy shares TODAY at a discount (100 shares at 18),…..OR he could simply buy a long term option LEAP for Jan of 2002 at $560. This LEAP contract will grant him, for the next 2 years, the right to purchase 100 shares for $20 each. In this manner he spends $560 instead of $1800, so he has $1300 extra capital to spend. If his research on WMI was correct and 2 years from today WMI is trading higher, he can exercise his option and he can now hold WMI for the long term. If WMI keeps tanking he will probably loose his $560, but then again he would have lost $1800 anyway if he would have purchase the stock .

3) I could be an ANALYTICAL investor and still use options as an strategy to accomplish my goals. Example: An investor has done a lot of research on DELL, he believes in its business model and would love to own a piece of it. However he thinks that 41 per share is a little much therefore he would prefer to buy it at 36. He is aware that timing the market is a fools game, but maybe he only has $3600 in his Ameritrade account and after watching Dell's historical price chart he thinks it is very probable that Dell will come down a bit. He could place a limit order…OR he could write a PUT (a DEC 40 at 4) . With this contract he receives $400 and for the next 2 months he could be obligated to buy 100 shares at 40/sh. If Dell never comes down, he will keep the $400 but doesn't get to buy the stock. If Dell does come down, he buys 100 shares at 4000 (he ends up paying $36 a share, 40-4) With the limit order he wouldn't get the stock if Dell went up and would pay 40 instead of 36 if Dell went down.

The examples listed above clearly illustrate just a few cases where investors could add Options to their investment strategy. Clearly, Options are not for everybody, buy and hold long can be the only strategy millions of investors use to prosper. But many others can certainly use an options approach that mimics their investment style. Hedging with puts for the more conservative, LEAP calls for the value oriented, etc…

It 's obvious to me TMF writers (including Dave and Tom) don't have a clear understanding of the possibilities that options provide, so I would ask that they do their homework in the area before they badmouth options. It's OK to discourage speculative investing (near term call options), but do not mix all option strategies into one single category. Some of us can be Fools, think long term and still get to use options. DON'T do a disfavor to all Fool readers by steering everybody away from options…isn't "Educate", part of TMF logo?
Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.