Liam Gibson
Wealth of Geeks
2023 has become a perplexing time for investors.
Markets caught a case of the summertime blues entering August, historically a slow time for stocks. The broad-based S&P 500 index dropped 4% since the start of the month, partially erasing gains made through the recent June and July bull runs.
Investment bank Morgan Stanley is now advising investors to hedge their bets and load up on high-yielding bonds as equities start to look shaky.
The uncertain outlook sets the stage for more volatility in the near term. As equity prices have dropped this month, the Cboe Volatility Index (VIX) has soared. This makes the outcomes of leveraged trading more extreme, with potentially even greater gains and losses.
Most investors require a sustained rise in equity prices to garner returns. Yet those buying and selling leveraged options can profit no matter which direction the market is headed. Fixed-term futures contracts (or options) may bring outsized returns when stocks are rallying but can be used to bet against the market, earning big bucks during a collapse.
Options trading has become more popular since the pandemic, yet the wisdom of the crowd here may be in doubt. Just because an investment style is trending doesn’t make it right for everyone. The outsized reward is inseparable from outsized risk. Financial advisors here share their thoughts on options and whether trading in these contracts is a smart money move for most clients.
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Want more options?
Trade in options contracts has surged in recent years. There were barely 20 million options trades per day before the pandemic. Daily volume then skyrocketed to 39 million in 2021, while last year it surpassed 40 million.
When leveraged effectively, options have the potential to multiply investors’ returns many times over. Yet, for options to be viable, traders need to have a clear strategy and know what they are doing. One defining feature of options is their flexibility. Contracts can be customized to reflect fit certain risk profiles, time horizons, and other factors. Traders can choose between hedging against losses with stop orders while also multiplying their potential upside returns with leveraged calls.
Options are not forever; indeed they expire. This means if they are not exercised in a timely manner, investors may suffer a total loss. Trading options thus comes with a steep learning curve, which is why learning the fundamentals is so essential. Investors who don’t grasp options’ core concepts like “strike price” and “time decay” would be best to stick to the sidelines.
There are many online resources for beginners’ options trading, including online trading courses, ebooks, and others. Once newcomers have the basics down and begin actively trading, other tools may come in handy. Options alert services can help investors move on to their desired trades while saving them time and freeing up their mental bandwidth.
By constantly monitoring short-term price fluctuations, these services notify traders when optimal buy and sell opportunities arise. Custom alerts can be tailored to fit your trading style, capital size, or market segment preferences.
There are also stock picking services, which leverage deep analytics and research to recommend which stocks to buy and sell. The thinking here is that trading in a preselected pool of hand-pick premium stocks preselected by specialists may help novice traders gain an edge. Most of these services advertise their strong record of outperforming market averages, although past performance can never be a guarantee of future results.
Some options picking services, like Mindful Trader, are priced at $47 a month, while others, like Investors Underground, cost almost $300 per month.
Consider the time frame, risk tolerance, and trading strategy implicit in each service to ensure the stock picker aligns with your individual investing philosophy and financial goals.
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Risky business
Despite the potential for serious gains, some advisors warn that options are just not worth the risk.
“Isaac Newton formulated several laws of the universe. If he were alive today he would add one for the options market: For every profit made, there is an equal an opposite loss,” says Jonathan Bird, Wealth Advisor at Farnam Financial.
“In order to make a profit over time in the options market, you by definition must be above average,” he continues. “In order to be above-average you need to have a knowledge edge over institutional investors. Option-trading alert services have zero edge on the overall market.”
“I would never recommend options trading to my clients. It is complex, and you can lose a lot of money quickly,” Joe Petry, Founder and Financial Planner at Mayfair Financial.
“People love the thought of making millions by outsmarting everyone else–seldom works out this way.”
Ultimately, the suitability of options depends on an individual’s personality, especially toward risk tolerance and time perspective. While strategic implementation aligned with an investment thesis can be rewarding, it’s essential to acknowledge the inherent complexities and risks.
Success in options, as in any investing endeavor, needs a deep understanding of market dynamics and a disciplined approach.
Markets remain unpredictable in 2023, and prospective traders must carefully evaluate the potential gains against the associated uncertainties and losses. Informed decisions and measured actions are imperative for long-term wealth building. It is important to keep in mind that while some may manage to big gains quickly, the vast majority of investors must play the long game to generate substantial wealth over the course of their life.
