Beware the Siren Call of Options Trading

I saw this happen with many people during the deflation of the tech bubble, and it will happen again but in a way that is slightly different from before, catching many off guard. The real pitfall here is that the amount of options premium becomes the most important criterion for stock selection. I'm sure this is not what the authors have in mind, but human nature is what it is.

To repeat from above, the market does not give away excess return for nothing. If the options market will pay 4% for a month of time, it is because the stock has a lot of risk. Some names like that in a portfolio make for good diversification, but a portfolio of 30 names like this makes for some real anguish at some point.

I know that there are people doing this type of trade successfully, and they may never have to face up to the consequences of the risk they are taking, but they are taking the risk nonetheless.

Covered calls can be a way to add some extra yield to a portfolio, but the mindset needs to be much different from that of someone looking for 3%-4% per month. When I say extra yield, I am thinking in terms of adding another 100-200 basis points to the overall dividend yield of the portfolio for the year.

For investors who are typically 1,000-share buyers of stock, they could sell call options on 200-300 shares on some stocks a couple of times throughout the year and achieve this little boost (no guarantee!) without altering the risk profile of the account. By only selling calls on a small portion, you are allowing the stock to run if something positive happens.

The point I am trying to make is one of moderation. Too much of anything, no matter how good, is, in fact, bad. Really, most people are better off without options, but if you want to dabble and are new to this trade, just realize that the options market does not give away money for free.

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