An Interesting Article from Barrons

[aiki14]

From Barrons online friday, 22 feb
Options Traders, Beware

MOST PEOPLE CHANGE THE CABLE channel when they see infomercials that promise easy millions trading foreign currencies or buying real estate with little or no money down. But when it comes to learning about options trading, the skepticism can easily fade away.

This can have expensive consequences for investors as the growing popularity of options is creating a booming market for options education. Not all information is created equal, and investors are well served to be skeptical of what they hear and read.

To be sure, some educators and newsletter writers are excellent. Investors can learn a lot from the International Securities Exchange's Alex Jacobson and the Options Industry Council. The Najarian brothers, who now run optionmonster.com, offer investors a chance to learn the business from former Chicago Board Options Exchange specialists. Larry McMillan of McMillan Analysis Services and Schaeffer's Investment Research have lots of good insights to share.

Sometimes, the hope of easy money makes investors susceptible to believing whatever they hear. At a recent investor conference, McMillan, who is widely considered one of the most authoritative options experts in the financial market, said some attendees told him some "options educators" were saying a covered-call strategy (selling calls on stocks the investor already owns) could be used to make returns of 5% per month. That's an unrealistically high return to expect from this conservative strategy. (Assuming that stocks don't tumble, a strategy like this is more likely to generate about one percent a month on average.)

"This sort of thing disgusts me because it gives the entire options industry a bad name," McMillan said. "Do people realize what kind of returns these are? Even at 5% per month, compounded monthly, that's an annual return of 80%!"

It gets better. He said he even heard one claim a few years ago that investors could make 16% a month selling "naked options," or contracts without an associated stock.

The name of the educators that make these claims is not important. What is critical, though, is that investors realize that loopholes exist that effectively make it difficult, if not impossible, for the Securities and Exchange Commission to regulate people selling expensive newsletters and charging a lot of money for investor education courses.

McMillan said people can make all sorts of claims about potential investment returns and never come until regulatory scrutiny because they are not required to register with regulators if they do not manage money or act as a broker.

"Even if it's a lie," a senior regulator said. "It's not a securities law violation. It becomes a violation when they recommend buying or selling securities, but these guys are smart enough to steer clear of that."

Even though the returns from options are can be exceedingly high in special situations like corporate mergers most investors have a very hard time consistently making high returns. McMillan, who also manages money, said he realizes annual returns of about 12% by selling in-the-money calls on Standard & Poor's 500 Index stocks. The returns could be higher in stocks that are not part of the index, but so are the risks.

Covered-call writing, for example, is generally considered a conservative options strategy by many investors. The strategy has become a favorite of many individual and institutional investors because it can lower the cost of buying stock, and potentially increase returns on stalled shares.

A good rule of thumb for covered-call writing is to only use the strategy on stocks you would not mind owning. "If you don't like the stock, don't do the trade - no matter how big the premium," said Michael Schwartz, Oppenheimer & Co.'s chief options strategist.

The SEC pays close attention to the options market, just like it does to the stock market. So far, the regulators have not offered investors much help navigating the cottage industry of options education and newsletters. That should change.

SEC has an investor education website www.sec.gov/investor with information warning about oil and gas scams and there's even a tool to check out brokers and investment advisers. But there is nothing to help investors think about options education and newsletters.

What SEC does offer investors is an email address for the Enforcement division and also an investor complaint form that is sent to the Office of Investor Education and Advocacy. SEC takes investment complaints seriously and if they receive enough of them rest assured something will happen.

Until then, investors can protect themselves by remembering a simple adage from ISE's Alex Jacobson:

"Good traders think of ways not to lose money. Bad traders think of ways to make money."

[Soverus Khan]

It's easier to call Kenny! LOL