Using Options as Part of Your Lifetime Investing Plan

Introducing Options to Your Investment Mix

Options Education
Learn about options. Public Domain

Once you gain experience with investing and believe that you understand how to make important decisions (especially where to invest your money) intelligently, then it may be the right time for you to expand your repertoire of investing techniques.

Do You Prefer a Hands-On or Hands-Off Investment Approach?

Some people find that they can achieve the best results by leaving all decisions to a professional investment advisor or planner.

Some handle the decisions — such as when to invest and more importantly when to rebalance — by investing passively in one index fund and one bond fund. They are quite satisfied to achieve market-matching returns.

Others have the desire and ability to delve more deeply into all financial matters, including how to manage an investment portfolio. There is no shame in belonging to the former group. After all, if you take care of your business/job/career — then it is reasonable to allow the financial professional to take care of your financial needs.

However, if you are one of those investors who prefers to take care of these important matters with a hands-on approach, my only warning is to be sure that you truly understand anything that you plan to do — before doing it. Too many investors believe that investing is a simple matter and may be blindsided when they realize that they missed out on important lessons involving risk management.

Learning to Use Stock Options

If you are completely satisfied with the performance of your investment portfolio; if you are comfortable earning money when stock markets rise and losing when stock markets fall; if you are content to own index funds and achieve results that mimic the returns of the overall stock market, then you may not want to take the time to learn how options work.

There is nothing wrong with that approach. 

On the other hand, if you would like your results to be less volatile (i.e., fewer large gains and fewer large losses), options can be used in conservative strategies to accomplish two good things for your portfolio:

  • Reduce the fluctuations in the value of your account.
  • Increase your chances of  earning more money (and reducing the chances of losing money) every year — but this wonderful result comes at a price that the investor must be willing to pay. Specifically, these conservative option strategies place a cap, or limit, on just how much you will be able to earn. The potential gains are excellent, but they are not unlimited.

Thus, as much as I recommend that the average investor take the time to discover whether using options is for him/her,  these strategies are best avoided if you are someone who is never satisfied when the profit is anything less than the best possible result. Greed is the enemy of successful option traders and if you would like to try to get rich quickly (folks — it's not going to happen), then I encourage you to seek guidance elsewhere. If you learn how options work, you can decide whether they are suitable for you and your investment objectives.

What to Expect When Trading Options

When it comes to trading options, it is not the use of option strategies that turns an investor into an investing wizard. Let me emphasize the importance of that statement. Just because you use options, it does not mean that you will suddenly turn into a superstar investor or trader.

Options are simply an investing tool, and tools are instruments that make it easier and more efficient to complete a task. If you are someone who consistently buys stocks that underperform the general stock market, then using options can provide slightly improved results. But if you are looking for a miraculous change in your profitability, then options will prove to be a disappointment because you still must choose where to invest your money.

The Importance of Learning an Options Strategy

There are a variety of option strategies that I can recommend to newer option traders.

However, when just beginning your options education, I urge you to think about one or two basic strategies that will generate these positive results:

  • First, you will learn to understand the most basic concepts about options and why they can be used as a risk-reducing investment tool.
  • Next, you will learn a great deal about for your investment account. Most investors never reach the stage of understanding risk. They tend to be bullish and buy stocks throughout their lives. This plan has been successful since the 1950's. But — and it is a big 'but' — some people panic whenever stock prices fall and they dump their holdings (often at the worst possible time, i.e., the market bottom). This group of panic sellers never achieves good results, no matter how well they do when markets are rising. They, as every investor, must develop basic risk management skills to become successful investors. Thus, an options education is important, even if you never use options because you will understand much more about managing risk and controlling losses. 
  • Third, your portfolio will, on average, outperform the market averages by a modest amount. These results are illustrated by comparing a buy-and-hold stock portfolio (S&P 500 Index) with the same portfolio that is using one of the conservative option strategies (BXM is the index that adopts covered call writing). 

As much as I recommend this strategy to the average, non-greedy, investor, I must stress that using options without taking the time to fully understand how they work will probably not result in meeting your financial objectives. In addition to the financial stability of your investing account, the primary benefit for the average investor is learning to understand how options are used to reduce and manage risk while investing money in the stock market.

As you will learn while undergoing an options education, some strategies are very similar to others and it is not necessary to adopt one specific strategy because identical results are available from equivalent strategies. Because this article is a generalized introduction, it is too soon for readers to be concerned with that statement. Just being aware of the truthfulness of that statement should be sufficient knowledge for now. For that reason, there are no links to more advanced topics.

Welcome to the world of stock options and investing with reduced risk.