Banjo Smyth

Who decided that options are too risky for the everyday investor? More importantly can somebody please explain why options are too risky? After years of research I have finally come to understand that there are 3 types of people that can be held responsible for the Myth that options are too risky. Who?

1. Financial Planners
2. Stock Brokers
3. Taxi Drivers

Is it possible for the uneducated investor to lose lots of money if they trade options? Yes of course they can, first of all the uneducated investor can lose tons of money using any trading instrument and secondly options are highly leveraged so if used incorrectly then they will increase your losses. So if this is the case then why an I saying that trading stock options isn’t risky?

The first thing that you must realize about stock options is that they were actually invested to reduce or manage risk. The whole idea of buying a put option to hedge you stocks is basically another form of insurance. When looking at your portfolio risk management options buying puts to ‘insure’ your stocks is one of the most conservative investment strategies that you can implement.

On the other hand selling call options on stocks that you already own (covered calls) is another incredibly conservative stock market strategy. This strategy actually increases your downside protection, so when used correctly the myth that options are too risky is simply not true. Of course if you start writing naked calls or naked puts then your risk levels are going to seriously increase but when used correctly options are an amazing risk reduction tool.

Let’s have a look at why financial planners, Stock Brokers, and Taxi drivers are giving Options such a bad name.

Financial Planners: If you go to your financial planner and say that you would like to include options in your trading strategies then they will almost definitely tell you that it is a very bad and risky idea. Why? Simply because 99% of financial planners wouldn’t have a clue how to use them. I recently spoke to a financial advisor who admitted that her entire financial planning degree only had one chapter on options and it was completely theoretical information. In their entire course there was not one bit of practical information about how to use options. So considering that most financial planners don’t actually know what stock options are let alone how to use them is it any wonder that their typical response is negative. Remember human’s beings fear change and looking stupid.

Stock Brokers: Surely Stock brokers don’t think that options are too risky? Aren’t they meant to be professional stock market investors? Unfortunately most stock brokers are exactly that ‘STOCK’ brokers not ‘OPTION’ brokers. To become a legal options broker there are additional courses that you need to complete so most stock brokers aren’t actually allowed to give you ‘option’ advice. Put yourself in their shoes for a minute – if a client came to you and said “What do you think of buying Options” then you are faced with two choices

1. Tell them that is a great idea but unfortunately you will need to take all of your money out of our accounts and go to another broker who is legally allowed to trade options, Good Luck with your investing.
2. Or you could tell them that options are too risky and you really should just stick to managed funds and stocks.

So what answer would you choose?

Taxi Drivers: Obviously this is a little bit of a joke but the point I am trying to make is that everybody seems to think that trading stock options is too risky. It is extremely important to remember to make up your own mind about investment strategies, whatever you do don’t take advice from a taxi driver about wealth creation.

“the most expensive advice you will ever get is free from poor people”

Kurek Ashley

So are Options too risky? If used incorrectly yes but perhaps the question you should ask yourself first is ‘what are stock options’? Before you dismiss something as being too risky or scary make sure you try to understand what it actually is and how it works. There are plenty of free resources on the internet so do some research and make up your own mind about stock options. The last thing you want to do is ignore something just because that is what everybody else thinks. After all are these people achieving the results you are after or are they still driving taxis?

Does the idea of a high risk high reward investment strategy excite you or make you scared?  It is the general perception amongst most people that in order to make spectacular gains you must take spectacular risks.  This is definitely a myth as there are plenty of investment strategies that allow you to make massive profits with very little risk.  Today I would like to have a look at some of the emotional and decision making processes that take place when using high risk high reward investment strategies.

Am I saying that high risk investment strategies are bad?  No definitely not, high risk strategies have a time and place but they must be one of many strategies that you use - not your main investment strategy.  I would also like to mention that there are plenty of ways to make high rewards without necessarily taking high risks.

If your broker suggested that you have a look at a particular trade that required $1000 that would double to $2000 if it was successful or you would loose half ($500) if it was unsuccessful - what would you do?

In my experience most people are pretty happy to accept the challenge and take a small risk for the prospect of a very good profit.

Would your decision change if your broker offered you the same trade but instead of $1000 you had to put $100,000 o the line.  So if successful your profit would be $100,000 or your loss would be $50,000.

Suddenly most people aren’t too keen to take on the trade - Even thought the odds are EXACTLY the same.  Obviously the prospect of loosing $500 is much less frightening than losing $50,000 but I believe that it shouldn’t make any difference to your decision making process.  A high risk high reward investment strategy is exactly that - an investment strategy that that has the potential to loose or win you a lot of money.  I prefer to look at all investment strategies as a percentage rather than in dollar terms.

This has two main benefits that are vital to developing a strong mindset that is vital when trading (especially if you are using high risk high reward strategies).

1.  It makes you look at the trade in relation to the actual value of the trade.  The above example is the exact reason why this is beneficial.  Should you place a trade that has the ability gain a profit of $100,000 or a loss of $50,000?  There is no right or wrong answer but if you start looking at the percentages of the trade you will be able to make a much clearer decision.  Always make sure the numbers stack up no matter how big or small the trade is and especially when you are using high risk high reward investment strategies.

2.  The best thing about looking at your trades in terms of a percentage is that it stops you from getting to emotionally attached to the profits and losses that you will inevitable have.  For instance if you were to make a $5,000 profit on one particular trade it is very easy to start getting ahead of yourself and spending the money on flights around the world, cars, boats etc.  If you keep focused on the Percentages you can be extremely happy with your trade but not get to over the top.

Using percentages is even more important when you have a loss on the stock market.  When you lose money is very easy to start thinking about how many hours of ‘normal’ work you have just lost and very quickly you are so depressed that you never want to trade again.  It is quite common for new traders to want to quit after their first loss on the market - even if they have still made a profit over all!  Using percentages gets you away from this mindset and makes you analyze your profits and gains in a much less emotional state.

So does this mean that high risk high reward investment strategies are a thing of the past?  No, it just means that you should really think about the pro’s and con’s of every investment that you make.  One of the main reasons why people love using high risk high rewards investment strategies is because they love the feeling of taking risks.  You only need to go to the casino to see that many people are addicted to the rush of gambling with their money.  The question you need to ask yourself when you are placing a trade is - are you Gambling or are you Trading?

One of the questions I hear every single day is “Where should I invest my money”? When you are just beginning your investment journey this is a very important question as it is vital that you get off to a good start. Too many people have one bad experience with investing and then turn their back on it for the rest of their lives. When you are learning where to invest your money the most common problem is that you have too many options.

I like to call this problem - “Option Anxiety”

The definition of option anxiety is when you have so many options to choose from that you start getting anxious about which one you are going to choose. Pretty soon you are incredibly stressed about which option you are going to take. All of the options start to look pretty good but you just can’t make up your mind. In the end you decide that all these options are simple too stressful and its much easier to do nothing. Does this sound familiar? It really is quite a bizarre thing but I’m sure everybody has experienced it at some stage.

When I first began my investing career I used to always get option anxiety when deciding where to invest my money. Should I invest my money in the stock market, should I invest my money in real estate, should invest my money in the bank – quite simply WHERE should I invest my money.

If you too suffer from option anxiety then don’t worry, it is an easy problem to solve. There are two main reasons why most people get anxious when they are investing their money for the first time.

1. The most obvious reason is because they have worked extremely hard for their money and they don’t want to loose it. This is a very natural emotion as nobody likes loosing money. If you come from a family that didn’t encourage investing then deciding that you want to invest can be an incredibly big accomplishment in itself.

2. When we are doing things that we don’t really understand we get scared. This is totally normal and in fact a very sensible thing to feel. If humans didn’t get a little bit scared when we were doing foreign things then we might get ourselves into a lot of trouble very quickly. In saying this it is very important that we don’t let this natural fear hold us back form doing anything.

So how did I overcome these problems and decide where to invest my money. I picked an investment strategy that I was comfortable with and then I built up my knowledge and got some expert advice. Pretty soon after that I was addicted to investing. So you are probably asking “how can I learn where to invest my money”.

Well the first thing to do is to decide which kind of investment you think you are most suited to. The obvious two choices are Property & Shares. As a general rule you will need more money to get into the property market (although this is not always the case) so it is often a good idea to start with the stock market. Once you have decided what option you would like to take I recommend that you start building your knowledge in that area and then once you have a general idea of what you want to achieve you can start looking for an expert to help you even further.

Don’t feel like you need to do everything on your own. Deciding where to invest your money is a very big choice so there is no harm in asking other people for help. If you wanted to become a dentist I don’t think you would assume that you could learn how to do it without getting an education from somewhere, would you? So what are you waiting for? There are thousands of free investment resources on the internet all you need to do is to find them, use them and then in turn you will begin to break down your fear of investing. Remember to become successful you need to grow and develop and the best way to do this is to increase your knowledge.

The secret to becoming rich is really quite simple.

First of all you must spend less than you earn – Then you must invest the difference.

But don’t stop there – You then need to re-invest the profits that your initial investment created as well as the original investment. In time this will create a big enough resource that you will be able to comfortably live of the income that your investments create.

Does this sound a little bit scary or like too much hard work? Well don’t worry because all you need to do is to create some savings and investment strategies and the rest will fall into place.

The first step is to create a Savings plan that works for you. When it comes to saving money there are generally two different types of people.

The first type are people who are somehow able to save money without any great difficulty. They have good restraint when it comes to purchases and they always have a sock full of money somewhere. When they are ordered around and given strict rules to abide by they tend to want to rebel and do the opposite.

The second type of person needs strict rules and regulations to achieve most things. Left to their own devices they would happily spend all their spare money on a new pair of jeans or car. When these people are given clear rules they seem to be able to save money with much more success.

Which type of person are you? Do you need strict Savings and Investment Strategies to save money or are you at your best when you are given more freedom. To be completely honest I think that everybody could become a better at saving money if they applied a few simple ideas.

One of the best savings and investment strategies that I have come across is this.

Reward Based Savings System

The first step of this system is to actually create a savings plan. For instance you need to focus on some areas in your life where you think you could save some money eg.

Bring your lunch from home

Quit smoking

Less alcohol from expensive bars

Cook your own meals

Public transport

Cut down on snacks

Isn’t it fumy how most of the things that I have just mentioned would be beneficial to your life in more ways than just saving you money? The problem is that all of the above things are actions and pastimes that you really enjoy.

So is it realistic to try and cut these activities out of your life and expect to be happy just because you are saving some money?

No, I don’t think it is. What about if every time you saved money you simply rewarded yourself? Then you might actually enjoy saving money rather than growing to resent it.

For example if you were to give up smoking then I would suggest that you keep a tally of the money that you are saving and use a portion of it to reward yourself with something that you love but don’t usually get, for instance a massage or a night at the movies. This way you are creating a savings plan that will actually work. Why? Because you want it to work so that you can get your rewards. Too many people create Savings and Investment strategies that don’t have inbuilt reward systems. The best thing about a reward based saving system is that you really enjoy the feeling of saving money. Then if you are smart enough to invest the extra money that you are saving you will have begum your journey towards financial freedom.

When you are investing on the Stock Market it can be a fine line between trading and gambling.  If anybody knew exactly what the Stock Market was going to do they would make millions of dollars everyday but not even Warren Buffet knows EXACTLY which way the market will go every time.

So how can we decipher between Stock Market Gamblers and Traders? Or do you think there simply isn’t any difference? I would like to look at one basic investment strategy that I believe is the main difference between Stock market traders and stock market gamblers.

Basic Investment Strategies – RULE No.1

‘You must know when you are going to get OUT of a trade BEFORE you get INTO the trade, no matter what happens to the stock eg. It goes UP, DOWN or SIDEWAYS.’

I believe that this basic investment strategy is the main difference between Stock Market Gamblers and Traders.

Why is this rule so important? Investing is about having a great plan or basic investment strategy and sticking to it. The last thing you need is to let your emotions take control of your investing. As soon as you let your emotions get involved you are beginning to gamble with your money. It is vital that you create a set of rules that you will follow no matter what happens.

If you are confused by the idea of knowing when to get out before you get in then I will quickly explain what I mean by this. When you enter a trade you should be aware of every possible outcome eg. The share price will rise, fall, move sideways or a combination of all of these. You need to know exactly what you are going no matter which direction the stock ends up going. This is an incredibly basic Investment strategy but you would be surprised at how many people enter into the market with no idea of what they are trying to do. This is my definition of a Stock Market Gambler.

So my advice is to start creating some rules that will become the basis of your perfect investment strategy. Once you have created the rules you should plot out a plan that you can follow and then most importantly you need to stick to the plan. Best of luck and happy investing.