Remember how I said I have a folder which contains a list of loser traders that I follow? Well, one of my 2 all stars is calling quits. He has to be the worst trader to have ever stepped on this earth..no joke! He recently came clean with his wife about the losses he has sustained during these past 2 years and he shared on a blog what he was going to say. Read this jaw dropping disaster...
Dear ____,
We need to talk and I need to be completely honest about some very bad news about my stock trading. I confess that I have been lying to you about my stock trading for the past two years and I have lost some large amounts of money. I apologize for withholding information from you and I realize that I have seriously betrayed your trust. I also realize that I have ignored your repeated requests to stop trading stock options and we are in serious trouble because of my foolish mistakes. I hope that I can someday regain your trust, but I know that may never happen.
Now, if she does not pull a knife from the kitchen drawer by this point, I have to explain the following details:
The bad news is that I have lost over $100 K from our joint investment account over the last two years. The net effect is that we owe $10000 to the IRS because I withdrew $40000 from my IRA to do some stock option trading. I was a complete failure at this trading project and have lost all of the money and have no money left to pay the tax bill. To make matters worse, I withdrew $7000 from our savings account in January to try to make enough money from trading to pay the IRS bill. I cannot do any of this successfully and lost all of the $7000 too. The only thing I can do at this point is to take $17000 from my Dad’s trust fund inheritance money to pay the IRS bill and restore our savings account.
The other bad news that I have to share is that my Dad loaned a large sum of money to me in 2008 for me to invest and I lost all of that cash by January 2009. Because of this huge mistake, my trust inheritance from Dad is reduced by $65000 and there is really only about $20000 left in the trust (maybe $25000 if I am really lucky).
Finally, to make matters worse, I have lost all of the money in my IRA ($300k) due to some very stupid trading. I can give you all the details if you want, but I am sure you do not want to know and there is nothing that can be done about this anyway.
This is a self destructive person with a gambling addiction to the extreme. This guy primarily traded options and folks, let me tell you about options, if you don't use them properly they are as dangerous as a child playing with a loaded gun like this guy learned the hard way. In fact, you'd be better off if you just never touch options whatsoever and I'll explain why.
The stock market attracts the gambling types...those who want to get rich quick without having to work. These people tend to be options traders, future traders, day traders or some combo of them. A lot of people who trade options tend to trade front month or 2 month expiry with out of the money (OTM) or at the money (ATM) strikes. They trade these because these options have high leverage and therefore offer the potential for big gains in a short period of time.
When you buy a short dated OTM or ATM option you have 3 things working against you immediately: time premium, volatility premium, wide bid-ask spread
To make a successful OTM or ATM trade, not only do you have to get the direction of the stock right (which is hard enough for most people) but you also have a very limited time to get it right. If you managed to succeed so far, next you need the stock to move in a magnitude that is greater than the volatility premium built into the option price. Therefore, it's possible for you to be right about a stock's direction, get the timing right and still lose money! Finally, you get nicked by the wide bid ask spread.
My advice about OTM and ATM options is to generally avoid them but if you want to know how to use them in the most effective way possible here's how….
1) Trend Trade
Buy the option on a counter-trend move of a well established trend (example, buy a call on the dip of an up trending stock) . Don't pick tops or bottoms with short dated ATM or OTM options. …you are almost guaranteed to lose money if you do that. The trend is indeed your friend because odds are a trend that's in place will likely continue to carry on in that direction and gather steam (especially during bear markets and the tail end of a bubble move). This gives you the best shot to overcome the timing and volatility premium factors that work against you.
Use an "all or nothing" approach. Either you make 100%+ or potentially nothing. The noise volatility and wide bid ask spreads make money management (i.e. trying to cut losses short) very ineffective for these types of options.
Most people get crushed playing OTM or ATM options because they tend to sell if they make a quick 10-20% but when the position goes against them, they ride it right into the ground for heavy losses and a big factor for doing that are the wide spreads. This is a very poor risk/reward equation which is why you should aim for big gains if you play OTM or ATM options….go big or go bust. If you don’t think you could make 100% or more on the trade then don’t make the trade.
Use at least 3 months until expiration. Give yourself time to be right.
2) Hedging
Using OTM and ATM options is a cheap way to hedge a portfolio. This is the only time you should buy an option that goes against the trend (example buying a put in a rising trend). Again, you should give yourself at least 3 months until expiration.
Don't go overboard with the hedging trying to profit overall from a counter trend move.
In my opinion, you should just stay away from ATM or OTM options most of the time. If you want to use options smartly for leverage then you use long dated, deep in the money options. For example, you can get about 4 to 1 leverage on the SPY and pay only a 3% premium if you buy a September 90 call which means if the SPY trades flat from now until September expiration, you would only lose 3% of your capital. This is far better than using those double or triple leverage ETFS whereby if you were to hold from now until September you can lose a ton of money if the market is flat due to the "decay" factor…you can even lose if the market actually goes in the direction you are positioned for!
Whatever you do, don't be like the sorry SOB I featured above who literally lost everything playing around with options.
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