Options trading seminars

Is options trading a dangerous get-rich-quick scheme or a low-risk strategy to profit from volatile markets?
 
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01 .Options trading

Stockbroker

In brief

  • Options are used by professional traders to manage risk, earn an income and make speculative investments, but they are also being pushed onto novice investors.
  • Options are not a guaranteed low-risk way to make big profits quickly.

Options trading is promoted as a “high profit and low risk” strategy to make money in rising and falling share markets. It sounds great, especially if you believe claims that “trading options is less risky than shares” and you’ll “identify low-cost trades in just minutes per day”.

One company, Optionetics, says if you don’t make 300% on your tuition fee in six months you’ll get your money back. Another, Traders Circle, recently said at a free seminar that if you start with just $4000, its options “mentoring program”, “recipe for success” and trading recommendations will teach you how to earn $1000 per month for the rest of your life.

The profits they estimate are alluring. Volatile and uncertain investment markets are the hook; slick sales presentations assure attendees they can profit from options whether share markets go up, down or sideways.

The Securities & Derivatives Industry Association (SDIA) estimates as many as 60% of the 75,000 options trades made each day in Australia are by individual investors, as opposed to financial institutions.

We attended free seminars and spoke to other experts to find out if options are really the best way to profit from volatile market conditions. We found options to be highly speculative, with a very real chance you’ll lose everything you invest. We also uncovered some dubious get-rich-quick claims that downplay these risks.

Please note: this information was current as of September 2009 but is still a useful guide to today's market.


 
 

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An option is a contract between two parties that gives the buyer the right, but not the obligation, to buy or sell a parcel of shares at a set price (the “exercise” price) on or before a future date.

There are two main types of options:

  • a “call” gives the buyer a right to purchase the shares;
  • a “put” gives the buyer a right to sell the shares.

The other party in the transaction, the one selling the option, is obliged to go through with the transaction on or before the option deadline if the buyer wishes it.

Options, a class of financial derivative, are commonly used by financial institutions and other investors for risk management. By paying what’s effectively an insurance premium to “lock in” a share price, a fund manager can limit the damage that a future fall in share prices would have on its investment portfolio. People with share portfolios can also sell call options, pocketing the premiums for extra income, while taking the risk that the shares appreciate and the buyer exercises their call option. But options aren’t just about playing safe – traders also use them to gain “leverage”, which increases the potential profits and risks without increasing the size of the initial outlay. Complex options strategies can also be employed as a speculative opportunity to make money.

More complex strategies

Buying a call or put option can be profitable or disastrous, depending on market conditions. Predicting share price trends, particularly in the short term, is notoriously difficult, even for professionals. Options trading education companies present complex strategies to address these difficulties. Techniques such as “straddles” and “strangles” involve buying a put and call option for the same share at the same time. Theoretically, by playing one option off against the other you can make money regardless of what happens to the share price. Investors use these strategies when they expect a big change in the underlying share price but are less confident about its direction. Another strategy is to both buy and sell options for the same share, with different strike prices.

Alternatively, an investor could sell a call and put option on the same share (known as a “short” straddle or strangle). In this case you’d hope the share price stays within a confined range, so that the buyers of your puts and calls won’t exercise their option to buy or sell them, and your profit will be the two premiums you’ve received. However, the risks with short straddles and strangles are great; if the share price moves outside the range specified by the options contracts, you may be forced to sell the shares at a very low price or buy them at a very high price – so your potential losses are unlimited.

Options trading is a complex, technical process requiring expertise. As one highly qualified equities trader told CHOICE, “it takes years to get your head around this stuff, and even that knowledge doesn’t mean you can make money”.

It’s this kind of knowledge that a number of options “education” companies propose to teach individual investors. One company is Traders Circle, which recently said at a free seminar that if you start with just $4000, its options “mentoring program”, “recipe for success” and trading recommendations will teach you how to earn $1000 per month for the rest of your life. Traders Circle claims that 80% of its options recommendations since 2005 have been successful and that every one this year has returned between 10% and 70%. By following their recommendations, Traders Circle claims investors can consistently earn 20%-30% profits per month.

We contacted Traders Circle to confirm what we’d heard at their free seminars. They clarified that profits are before costs described in the company's financial services guide including trading fees (up to $82.50 per trade), education fees ($7000-$13,000) and monthly subscriptions ($349), and before losses from unsuccessful trades.

Another company is Optionetics, a US organisation that claims to have introduced 336,000 people to its “reliable, carved in steel, highly effective trading method”. It runs free two-hour seminars nationwide. In Australia, it’s an authorised representative of Investment Educators Australia, which has a financial services licence and also authorises Safety in the Market, another company that runs investment seminars and shares the same office. Under its licensing arrangement, Optionetics is permitted to provide general but not personal advice about certain financial products, including derivatives.

Optionetics seminars give an overview of these complex investment products, play videos of testimonials from apparently happy customers and show examples of successful and highly profitable trades. They end with a sales pitch to the audience to sign up for an intensive education weekend with “lifetime reattendance”, plus options trading software materials and support. The price is $5795, discounted to $3995 for those willing to flash their credit card or chequebook on the night.

The company says 10,000 people in Australia have paid for its training and software, and reassures prospective customers with guarantees they can return the product for a refund within a few weeks if it’s not for them. If a person decides to continue but doesn’t make big profits quickly, the company also promises to refund the money – provided the person is prepared to satisfy its strict conditions.

Pot of gold

Optionetics claims that by signing up for its education course, following its trading strategies and making at least 36 trades, you can earn “300% return on your tuition fee in six months or you’ll get your money back”. That amounts to a $12,000 profit if you paid $4000 for training. However, 300% in six months is an enormous return – more than professional investors could dream of making on a consistent basis. It’s about 200 times what you’d earn with a bank deposit and 120 times the average annual return over the past five years from a professionally managed superannuation fund investing in shares. You’d also have to factor in your transaction costs; buying and selling 36 Australian options contracts (72 trades) could cost more than $3000 in broker’s fees, even if you used a major bank’s online discount broker.

The seminars present examples of even more spectacular profits made by Optionetics teachers and customers, including:

  • $60,000 profit in six weeks on a $2000 call option – a quick 3000% profit
  • $50,000 profit on a $675 option (about 7000% profit)
  • A customer turning $94,000 into $638,000 (579% profit) by following the Optionetics system.

Risky business

While the risks of options trading are described and the company proposes to teach people how to set predetermined entry and exit points for trades as a way to cut their losses when markets move the wrong way, there’s far less focus on the losses that customers must also be experiencing.

We’re not the only ones sceptical about the potential profit claims. “While it may be possible for such returns to be achieved, it would only result from adopting risky strategies,” says the SDIA’s Doug Clark. “The risk of loss from trading in options can be substantial. In all investments, high returns usually mean high risk. A good options adviser is invaluable to help you understand the market and give suitable advice.”

Rod Peters of ABN AMRO Morgans uses options for private clients, but mainly for capital preservation and to earn an additional income, rather than to speculate on big profits. He says 1.5% profit per month, or even double digit figures in a year, would be “a phenomenal return” from options, even for someone prepared to accept some investment risk. “I don’t believe the higher returns being quoted by these options education companies are sustainable,” he says. “Any astute investor would realise that to achieve those returns you need to get lucky, take extreme risks, or both.”

Definition of "loss"

CHOICE put it to Optionetics that statements claiming people can make profits like 300% in just six months while taking low risks are akin to get-rich-quick claims. “It is not a get-rich-quick scheme and we don’t promote it that way,” insists Wayne North, the company’s General Manager Asia Pacific. “We teach clients how to take a profit and limit their risk. You don’t need to get many trades right to make a profit.” The company doesn’t know or track how many customers earn 300% profit in six months, but says it receives very few money-back claims. Optionetics argues one reason options are less risky than shares is that the stakes are lower. “With shares you risk 100% of your investment,” says North. “Well, that’s also the case with options, but they’re a leveraged risk product. With an option, you can invest 3%-5% of the value of shares and ‘control’ them. If share prices move the wrong way, 3%-5% is the maximum you can lose.”

Herein lies the problem with such claims, which perpetuate consumers’ misunderstanding and underestimation of the risks. The stark reality is each time you buy an option you could lose 100% of your capital or investment (and if you sell options, your potential losses are unlimited). The size of an investment or bet bears no relation to its chances of success or failure. That your trade costs 5% of the face value of the underlying shares doesn’t reduce the chances of losing money.

Number crunch

  • $1 TRILLION is what $1 would grow to over 10 years, if 300% were earned and compounded every six months.
  • $425 BILLION is the value of $1 after 10 years, if it grew by 25% per month, compounded monthly.

If such consistent profits were really possible, would these companies waste their time running seminars?

Optionetics claims these calculations are sensationalist. Traders Circle says the figures are “out of context with how we explain our education service” and it recommends periodically withdrawing some options profits to put into more conservative investments, rather than reinvesting all profits in further options trades.

However, our calculations should make investors seriously analyse the returns they can expect from options trading.

Here’s a real example of how a call option works.

  • NAB’s share price at 24 May 2009 was $22.
  • You could buy a June call option with an exercise (or “strike”) price of $22, for 52c.
  • Because Australian options contracts are sold in lots of 1000 shares, the price of your options would be $520 (52c x 1000), plus your trading (broker) costs of about $40 per trade, so a total cost of $560.

How you could win

  • Assume the share price moves to $23 by the end of June. If you waited until then, you’d have the right to exercise your call option, buying NAB shares for $22.
  • Because the shares are now worth $23, you can sell them and pocket a profit of $1 per share. Or, as is more common, you could sell your call options for a higher price than you originally paid for them, giving you a similar profit.
  • After you subtract your costs (remember the call option cost 52c per share) you’d be left with a profit of 48c per share. Your overall profit, after subtracting the cost of trading ($80 for two trades in this case) would be $400, or 71% of your original investment.

So how does this compare with investing the same amount ($520) in NAB shares instead? In that case, you would have purchased 23 NAB shares. If the price rose by $1 and you sold the shares, your profit would be $1 per share, or $23. This wouldn’t even cover your brokerage fees, so in this example, with the same original investment ($520), options would be far more profitable than shares.

How you could lose

  • If you bought a $22 call option for NAB shares, and the share price dropped to $21 by the end of June (and assuming you didn’t cut your losses and sell the option before then – a “stop loss”), your option would be worthless. There’d be no point exercising your right to buy the NAB shares for $22 and your loss would be what you paid for the call option and the brokerage fee – $560 in total.
  • In this case, it would have been better to have invested your money in the shares, which would still be worth $21 each, just 5% less than what you paid for them.
  • You could also have benefited by buying a put option, instead of a call. A put gives you the right to sell shares – in this example, for $23, which is $1 higher than the eventual share price.

Education, but no profits

PeterPeter, a software engineer and CHOICE member, attended a free Optionetics seminar and subsequently paid for the two-day seminar, software and a further three-day advanced course.

We asked Peter if he’d profited from the training and software. “In a financial sense, no. I don’t want to trade the US market [where the company strongly recommends you play] and I did not strictly follow the rules. However, from an education and avoiding financial destruction viewpoint, I have benefited. I truly understand how options, contracts for difference, warrants and shares work. Many people just don’t understand the risks; Optionetics drummed home again and again the very real risk of trading derivatives.”

Peter is generally impressed with Optionetics’ presenters and materials. However, he’s critical of the “shocking” software costs and what he terms “high pressure, no-nonsense sales techniques” and “constant upselling”. “I think the knowledge they dispense is of an exceptional quality, but overpriced.”

Peter has spent close to $10,000 on education and materials. He‘s lost further money trading options, but stresses the unsuccessful trades didn’t follow Optionetics’ strategies. He applied his own strategies and learnt the hard way how difficult it is to make profits.

Peter’s advice to others considering attending an options seminar or training course is to “be calm and critical – you are not obliged to buy or do anything just because it’s a free introductory seminar. Think further about the offer, search the web for the knowledge Optionetics claims to teach you, check out bookshops and the much cheaper material available, take an active interest in learning yourself, then go back to the next free seminar a little better armed to make a judgment call. And most important of all: this is not some magic bullet that will save your financial mess, or some quick-fix solution.

"Don’t give up your day job, and don’t go into debt to buy any of this stuff or to trade options. Be patient and save if you really want to attend these seminars.”

Our verdict: look before you leap

Options are legitimate financial products and trading them can work, but to be successful you’ll need significant time, skill, expertise and mathematical abilities. With options, no wealth is “created”, merely transferred. You pit your wits against an efficient financial market; the prices you pay have generally already factored in the experts’ opinions about what might happen in the future.

Trading optiosn is not easy, it’s not low-risk, and big profits are anything but guaranteed. Stockbrokers say the only reliable way to make money from options is by writing (that is, selling) call options against large share portfolios you already own. But of course such trades also have risks – a rise in share prices could force you to sell your shares for less than they’re worth.

If you do want to pursue options trading, instead of paying out thousands of dollars for training and software, start with free online content, books and other relatively inexpensive materials to educate yourself.

A $40 book can explain both the basic and more complex strategies and give you a feel for whether options are for you. For ideas about where to start, see below.

Other industry opinions

Options are used by professional and institutional investors to hedge (insure against) their risk or exposure to changes in share prices. Sometimes they sell options to pocket the premiums and hope the market doesn’t move against them; in other cases they buy options to hedge risks or take speculative positions that could earn them money.

Some financial planners, such as Marie Bermingham, occasionally use options as a way to protect individual investors' share portfolios. "We use options as a protection and risk management strategy, but not as a way to make money," she says. "Options have proved to be an absolute winner over the last two years. At end of 2007 and early 2008 we locked in some good share prices for clients, before the share market downturn, preserving their capital." However, Bermingham doesn't think average investors should trade options looking for big profits. "Options are not for the fainthearted and only sophisticated clients and investors should use them. It's possible to make money, but it is also possible to lose a lot of money. I wouldn't recommend giving up the day job. And you don't need to buy expensive software to trade options, but you do need quite a bit of knowledge."

James Ramsay, an equities dealer with stockbroker Bell Potter Securities, also warns consumers about the dangers of options trading. "Without strict risk management strategies in place, options can go against you and wipe you out. Don't trade options if you're not a sophisticated investor or don't have a knowledgeable adviser. Options have their time and place but you just need to know when to use them."

“Trading stocks is hard enough, but options are a whole lot harder,” says Travis Morien, a financial planner. “Options were designed as a tool to allow people to manage risk. It’s ironic therefore that in the hands of speculators they can be the most risky investment of them all. Options are much harder to analyse than stocks. In general, I think about amateurs trading options pretty much what I think about amateurs doing brain surgery, with high explosives. It usually ends badly.”

Sean Nofal of amscotOnline, a discount stockbroker offering share trading but not options, emphasises the view that any market strategies are best kept straightforward. He says the brokerage favours very straightforward strategies in markets which are as transparent as they can possibly be. "The appeal of derivatives is based on two factors - leverage and time value, both of which involve significantly increased risk. Time value involves using a rocket-science style formula which is designed to encourage buyers of risk to pay more than it's really worth, sometimes by a very wide margin. It might all sound very scientific and exciting, but those embarking on complex options strategies involving multiple straddles and strangles can expose themselves to unforseen and dramatic risks. Your analysis needs to be totally accurate. If not, you wouldn't be the first, including many professionals, to totally blow yourself up." In investing, as in most things, Nofal advocates KISS - Keep It Simple Stupid. In this regard direct investment in ASX Equities fits the bill.”

More information

The Australian Securities Exchange provides free options fact sheets and audio-visual presentations on its website. Its book, Trading ASX CFDs, Options and Warrants the ASX Way, is published by Wrightbooks and retails for $39.95.

Become familiar with the derivative (options) tables and figures quoted in daily newspapers, such as the Australian Financial Review and on the ASX website.

Two-hour introductory Options Fundamentals training courses are available from the Securities and Derivatives Association for $764.50 for non-members. While mainly attended by new entrants to the stockbroking and financial planning industries, the SDIA says these courses assume no knowledge and are suitable for investors considering options in their trading strategies.

You can also check out what other readers say about options trading and these seminars, and have your say.

We asked CHOICE readers to tell us about their experiences with trading options or attending seminars. Here are some of your comments.

It takes more than 20 minutes per day

"I attended an options seminar in 2002 and, while I thoroughly enjoyed the program and felt I learnt a lot, I believe that the instructors give a false impression in relation to both the amount of time and effort required to trade properly. It was stated during the seminar that, provided we put alerts and stops on our buys, we would need to spend no more than 20 minutes per day to trade successfully. However, I do not believe this to be true and feel, particularly if you are working in a full time position, that it is simply not possible to monitor your trades effectively enough to be successful." Fran

Strategy failed when share markets crashed

"I have attended all of the courses that Optionetics offer and found them to be quite well structured and generally conducted by top quality instructors/traders. I also purchased several of their software offers, although I do not currently use them as I have found a Broker who offers more than I need for my trading.

"I do not subscribe to their low stress/high profit trades as I believe that their main failing is in not what they say but rather what they do not say. They tend to teach more about how to use the software rather than the nuances of trading.

"I was making money using the Optionetics strategies, but got caught out in the October crash last year. The strategy I was using at the time was one recommended by Optionetics and was bound to come unstuck in a major fall like was experienced with the collapse of the financial sector.

"I do not regret purchasing the software nor do I regret attending the courses, both in Australia and the US as I do not believe I would be where I am currently if I had not gone down that road. This is my story and may not be the case for another student. I have since found another trading educator who offers much better value for your money as their publications are much less expensive, better presented, lacks the American hype of Optionetics and deals with the nuances in detail, which I believe is needed if one is to make money in the trading game. I have been far more successful using the education from the new company. My main losses have been through my lack of discipline rather than their education.

"Would I advise a newcomer to attend their courses? Well that would depend on the person. If they wanted to be spoon fed then I might, if they are the type who are prepared to roll up their sleeves and be serious then I believe I would steer them in a different direction and save them multi thousands of dollars. This type of person would not need the software."- [Name withheld to protect identity]

High returns mean high risks

"I trade options and have attended a few of the free "teaser" seminars that aim to encourage people to pay for the full versions. I know people who have attended some of the paid courses, but do not consider they have really benefited. It is difficult to tell with some of these however. I have undertaken a course in futures trading offered by a different company, and was very disappointed. As part of this, I accessed the live "trading room" while trading S&P futures. This did not meet my expectations most of the time.

"I have traded options successfully, which means on average I make money. Not every trade is successful or optimal either. The approach I am currently using will deliver approx 25-30% per annum on funds employed. Making 1.5 to 3% per month does not grab the excitement headlines, or many people's attention. The advertising material I have seen indicates much higher returns than this are achievable in every trade. This does take a fair amount of work, and has a high level of risk.

"Liquidity is the main 'problem' in the Australian options market. This can therefore have significant effects on options trading. It is easy to get into a position and then not be able to get back out of it. The Market Makers are also able to "play" individual options traders/investors as they are easy to identify. This can make entry/exit more costly as they can increase the spread significantly, assuming they even want to get involved. Most trades are made with Market Makers rather than other traders.

"A good measure of how good the courses actually are, is how many people who attend actually make money. I imagine the course providers do not actually collect such information, even though success would be a very good marketing tool. From what I have seen, people blame themselves for not getting it right when they lose money. Consequently there is a big focus on psychology, which can help perpetuate the feeling that the people trading are to blame for losses. Psychology is very important, but good psychology won't help you if you don't have a good trading plan, system or methodology.

"There are many different aspects to trading options, and many different things that affect the outcomes." - Nicholas

Selling the dream - and expensive seminars

"I have always been on the lookout for ways to increase and diversify my income stream - and in doing so have become very cautious in who I deal with after being bitten a few times (as you could imagine). I have been to numerous 'free seminars' by various spruikers over the years. Most of them were the 'Property Investing' seminars, and also the Optionetics seminar. They all work on the same principle - Offer a 'FREE' seminar where they basically sell the dream (Look at me, you can be like me too, all you have to do is follow some simple rules and look at the results) followed by presentations of the results and some very minimal 'examples'. Essentially, the whole 'Free' seminar is one big advertisement to sell the Product - which is their Classes and Software.

"I went to a Free Optionetics trading seminar approximately 5 years ago. Whilst I found some of the information of use, most of the seminar is designed to hype the person into buying the training package. One of my friends who attended the seminar with me, registered for the whole package, but was disappointed to find out (much later on) that Optionetics didn’t include software packages or nearly enough support. Most of the support that was provided was from other students. It was covered by the typical 100% money back satisfaction guarantee that a lot of these spruikers offer.

"I have since joined another group who ONLY advertise through word of mouth. The course is FAR cheaper, and in my opinion FAR better. The teachers are ACTIVE Traders who derive their primary source of income from their Trading as opposed to selling courses/software packages and on payroll from another company.

"The biggest problem I've found with a lot of these training companies that offer 'free' seminars is that the courses they spruik are expensive (probably to cover the HUGE cost of marketing that they must incur) and the content of the free seminar is purely a marketing vehicle to build hype for the product." - Paul

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