occurred in the Reagan Crash of 1987; the money puts bought at $0.625 on
October 16 were worth hundreds of dollars on October 19—if you could get
the broker to pick up the telephone and trade them. (The editor had a client
at Options Research, Inc. during that time who lost $57 million in three
days and almost brought down a major Chicago bank; he had sold too many
naked puts.)
The most sophisticated and skilled traders in the world make their livings
(quite sumptuous livings, thank you) trading options. Educated estimates
have been made that as many as 90% of retail options traders lose money.
That combined with the fact that by far it is the general public that buys
(rather than sells) options should suggest some syllogistic reasoning to the
reader.
With these facts firmly fixed in mind, let us put options in their proper
perspective for the general investor. Options have a number of useful
functions, such as offering the trader powerful leverage. With an option, he
can control much more stock than by the direct purchase of stock—his
capital stretches much further. So options are an ideal speculative
instrument (Exaggerated leverage is almost always a characteristic of
speculative instruments.), but they can also be used in a most conservative
way—as an insurance policy. For example, a position on the long security
side may be hedged by the purchase of a put on the option side. (This is not
a specific recommendation to do this. Every specific situation should be
evaluated by the prudent investor with professional assistance as to its
monetary consequences.)
The experienced investor may also use options to increase yield on his
portfolio of securities. He may write covered calls or naked puts on a stock
to acquire it at a lower cost (e.g., he sells out of the money put options. This
is a way of being long the stock; if the stock comes back to the exercise
price, he acquires the stock. If not, he pockets the premium.)
There are numerous tactics of this sort that may be played with options.
Played because, for the general investor, the options game can be
disastrous, as professionals are not playing. They are seriously practicing
skills the amateur can never hope to master. Many floor traders, indeed,
would qualify as idiot savants—they can compute the “fair value” of