Customer Reviews

Options Trading for the Conservative Investor: Increasing Profits Without Increasing Your Risk

5 star:		(6)
4 star:		(7)
3 star:		(6)
2 star:		(1)
1 star:		(3)

 

 

I would consider myself a value investor and don't buy stocks with large p/e, p/book or p/sales ratios. I never considered options, because I thought they were only for speculators, until I read an article in Barron's mentioning options in a conservative way. Then I came across this book, and I have to say, it is exactly what I was looking for. It explains in a great way how to use options when you're serious about "investing" and not a gambler/speculator.

The book doesn't of course tell you how get rich quick (otherwise it would not be a good book). But it tells you how to take advantage of market conditions without adding risk to your stock portfolio (with the exception of the risk of lost optortunity). The book uses actual excamples (using closing prices of October 2004) and walks you through most of the scenarios with real option/stock prices, which is a great feature.

The only negative I have with this book, is, as my review title states, that he keeps repeating himself to the point, that it really gets annoying. He probably mentions 20 times that, in a conservative way, you should only consider options of a stock that you consider good long term investments. That is a valid point, and one of the assumtions for the entire book. But it would have been enought repeating it maybe 3 - 5 times.

There are numerous examples of repetition and sometimes I wonder if he wrote the book in a rush without reading the preceeding chapters. There are a lot of sub-chapters, which are sometimes just pure repetition of other sub-chapters in another chapter.

There is one scenario which I wish he would have walked through with actual stock prices. The scenarios of rolling up/forward. Since from my (theoretical) understanding, it is very difficult on a net credit basis. But I'll try that out for real, and then I'm sure I will figure it out.

Anyway, I still give this book 5 stars, because the strategies described in this book are invaluable for any serious investor and I can't wait until my broker finally approves me for option trading and I can try these strategies in the real world. I wish I had had that knowledge a couple of years ago, when I was holding some stocks, which had a huge runup, but I didn't want to sell them, because I wanted to keep them for the long run. Now I would know what my "options" are of protecting paper profits.

Most conservative and moderate investors will tell you they seek increased returns without adding additional levels of risk to their portfolios.

They are not adverse to risk; they just seek to control it. In short, they seek to

1. Preserve spending power after both inflation and taxes.
2. Seek to avoid unacceptable market, liquidity and diversification risks.
3. Protect profits without loss of invested positions.

If you fit this investment profile, then Michel C. Thomsett has written this book for you. In it he demonstrates how carefully selected options strategies can help you consistently improve your returns without adding additional portfolio risk. Options, he argues, do not have to be exotic, high risk or complicated. In fact, they can be employed as a powerful tool to reduce risk.

He wisely sets his ground rules early in the book. They are:
1. Limit options activity to stocks you have pre-qualified.
2. Have faith the market with rise over time.
3. Accept the value of fundamental analysis.
4. If trade down, be prepared to add to your position.
5. Believe there are an adequate number of stocks which will meet your investment standards.

Thomsett's book is well-written and illustrated - even if you are not familiar with options. In 255 pages he covers options strategies suitable for conservative investors. He includes covered call writing, contingent purchase strategies, rescue strategies to use when markets fall and combination strategies that produce cash to bolster current income.

If conservative and moderate investors remain true to their goals, options are a wonderful tool. However, Thomsett is experienced enough to acknowledge that deep in the heart of every market hedger is a speculator eager to spread his or her wings.

Stick with the author's ground rules and you will avoid the market's playground of temptations.

I think that this book could be helpful in following a conservative option strategy. However, there are a number of errors in the book that make for confusion. For example, on both pages 197 and 220, there is an instance in the middle of discussions involving straddles where "spread" has erroneously replaced "straddle". The chart on page 213 is useless due to printing being superimposed on printing. I would guess that the latter error is the printer's fault but the former errors are either the author's or editor's fault. For $34.95 I expect more care in the publishing of a book like this.

In OCI author Thomsett presents a conservative approach to protecting and augmenting equity built up in a portfolio made of fundamentally sound stocks. I have successfully used some of these strategies in my account and turned some profit.

Introduction

You can expect some frustration reading the first part of the book. Leaving aside the spelling errors and other editorial deficiencies, this part of the book is full of repetitions and could have been organized better.

Stocks And Timeframe

The advantage of selecting fundamentally sound stocks is to ensure that stock will appreciate over time. It may sound disappointing that these techniques would require to hold stocks for 2-3 years (for tax consideration) but looking at my portfolio I see only stocks I've held for many years and I wish I could have applied these techniques earlier. Because fundamental performance needs to be evaluated only so often, e.g. after earnings reports or other announcements, it leaves a lot of time to dedicate solely to the analysis of option strategies.

The author does present a simple method for selecting such stock and it should be have been at the start of the book, not the end.

Strategy 1 - Taking Profits Without Selling Stock

The first strategy proposes an alternative to selling stock in order to take profits on a stock that has appreciated and is currently overbought. This consists in selling covered calls and/or at the same time buying puts to insure all or some of the stock from a decline.

Mr. Thomsett reuses this strategy with different parameters (a form of a zero-cost collar) as a means to exit a position when its fundamentals change which I also recommend as a means of initiating positions in stock.


Strategy 2 - Alternative to Buying Stock - Selling Puts and Buying Calls

The second strategy provides a set of possible actions with a stock that is currently depressed and presents a buying opportunity. As alternatives to simply buying more stock on the dip, the author proposes the writing of naked puts as a means of acquiring more of the stock currently owned. Alternatively, he recommends buying calls in the case when it is uncertain whether the stock is merely dipping or is beginning a bear market.

In this context when the stock falls below the overall cost-basis the author proposes a number of rescue strategies to convert the paper loss to break-even or even a paper gain.

The book also gives enough consideration to the call backspread and calendar spread strategies, which I am going to try next.

Strategy 3 - Combinations

In the latter part of the book the author presents a number of combination techniques, such as modified short straddles, which seem to be the author's favorites. The continued premise is that all trades are based on conservative considerations.

These strategies propose a higher return but induce higher risk, which can be mitigated with careful timing and selection of entries.

Overall, each of the above strategies is explained in detail and each outcome is thoroughly considered. The rate of return for each strategy is annualized and the author constantly reminds you of the tax consideration for each strategy.

Applying the strategies in this book helped me get comfortable with options and want to research more. I soon found out that volatility is of such great importance to option pricing that it may affect all other considerations. For example, volatility can skew the effect of time decay a great deal and cause options to keep a lot of time value until the last two to three months before expiration. You should consider LEAPS only after having successfully applied intermediate-term strategies. Suppose you write a covered LEAPS call and then the stock drops and you change your mind about keeping it. Because the call is so far away, it won't depreciate as much as the stock and thus may prevent you from exiting the position profitably.

It is rare that you hear the words options and conservative in the same sentence so most readers probably turn their eye brows up at this books title. The author believes that there is a way for the risk adverse investor to use a strategy to trade a narrow band of options and beat asset classes averages. His argument is that some conservative investors are investors that are open to expanding beyond the Dow and CD's yet are still going to make sure that they examine the risks and make sure that they are acceptable.

We have all heard that high risk means the potential for high return. The problem is the high risk part. The author claims that by increasing your knowledge you can limit the risk and leave the majority of the losses to the inexperienced and uninformed. This book gives the reader a limited number of strategies appropriate for conservative investors that are looking to limit risk while expanding investment choices. Overall the book was well written and easy to understand. I do not know if I am going to jump into options trading, but if you are looking at new investment options, this author explains this asset class and gives the reader a nice set of strategies.

Overall lots of information, but Thomsett does not fully explain the risks involved with selling covered calls. Essentially all of his model portfolio would have been in the money after selling the Leaps wtih in weeks. Rolling would not be practical as one could only roll up for the 27 month Leaps. Selling a Pepsico 27 mo. Leap at 50 with a current price (in Sept of '02) of 48.48 netted a $4.30 premium. The stock hit $50 within a month or so and was at about $63 by expiration. The only way out would be to roll up (at an ever increasing cost), hold for two years, or buy back the call. For the average investor (including myself) seems a bit complicated. If after selling a call, the price falls, the risk is even greater. One would need to close out the call by purchasing it back before selling the shares or risk having a naked call. The stradles described later in the book may reduce risk but for most trading accounts managing margin is not for the faint of heart. Definitely read this book with a large grain of salt and thourghly understand the risks associated with such options trading.

I wonder if there was an editor actually involved in the process of publishing this book. On the plus side, there are many excellent ideas presented in the book, however it is redundant, full of errors, and poorly organized. I was frustrated by the start of the book which assumed a much higher level of knowledge than I possesed being a beginner in options trading. But later chapters actually explained what was very unclear at the start of the book. I then had to go back over the beginning of the book to understand what the author was trying to say. It would have been much better to start simple and then increase the level of complexity.
The book was also very redundant. It tended to repeat itself. Sometimes it would say the same thing many different times in different parts of the book. I often found myself thinking, "didn't I just read this a few pages or chapters ago?" Did I mention that the book was redundant?
Finally, the book was full of errors and not just typos, although there were many of those. One example spoke of a 45 strike price for Pepsi but the corresponding table had no such strike price. I assumed it was talking about JCPenney which did have a strike price of 45. This is just one of many examples presented in the book that contained errors. Now you might think that I simply didn't understand what the author was saying, but as an engineer and a math teacher that earned a full ride scholarship to college and scored in the 99th percentile in logic and math on the GRE I would like to think that I can percieve an error when I find one. Perhaps a revised edition can correct many of the errors, change the order, and eliminate much of the repetition to create a much better book.

I purchased this book because the seemingly counterintuitive concept of using options as part of a conservative investment strategy was intiguing. The author is knowledgable and authoritative. Although there is an effort to present basic information, it is not comprehensive - the reader needs to do some preliminary reading before tackling this book. I have two problems with the book. First, it is very poorly organized and written. It has the feel of a book hastily prepared for publication. Chapter contents bear little relation to chapter titles and there is much repetition. Rather than being helpful from a pedagogical standpoint, the author's rambling repetion confuses rather than illuminates. The author is also prone to awkward locutions - he was painfully ill-served by his editor. Second, I was not fully convinced that the author's proposed strategies are, in fact conservative. They seem to depend to a great degree on market timing which as most seasoned investors know will hinder ones plans as often as it helps. The case for "conservative" options strategies as opposed to traditional buy and hold approach is not made.

First and foremost, Thomsett's books are clear, compressive, and easy to follow. You'll never find yourself confused or dumbfounded by the hardest topics when master author Thomsett teaches them.

Thomsett has written options books for the novice before however in this book he focuses on strategies that conservative investors can employ and which ones to avoid. Often time's equity options are something that are thought and used in high-risk schemes but Thomsett shows their value in how they can be used to reduce risk.

While the strategies explained in this book won't and never promise to make you a King's random, (but they could actually save you the same amount). It does provide sound and proven techniques. It will show how you can use options to hedge and protect gains in your investments. How you can produce extra income from the stocks you already own. How you can use your equity or cash balance to produce extra income and buy stocks at a discount. And most of all, how you can reduce stock risk and create steady capital gains and income from your portfolio.

You may not get rich quick but you certainly won't go to the poor house as Thomsett shows you can you reduce your risk and increase your profits in stocks.

Essentially a book that attempts to frame options trading in a world where your fundamental analysis of a company will drive strategy. The basic assumption of this book is that you can effectively analyze the fundamental strength of a stock and that you can execute several options strategies to increase the income generated from the stock. However, many of the strategies presented still require one to utilize technical analysis (e.g., choose strike prices based on support-levels), as well as provide little in the way of strategy modiifcation if the company's fundamentals change during the life of a call. This is a good book for developing some new investment strategies, however the reader will benefit if they have a good understanding of technical analysis as well.