Options traders focus, often too much, on implied volatility to estimate the next change in option valuation. Is this always a wise policy? Options are derived from volatility in the underlying security (thus the term derivatives), a good question is: Why not focus on volatility trends in the underlying (historical volatility) to judge likely future valuation trends in options?
In our Bitcoin: The Greater Fool Theory article, we discussed how the most popular cryptocurrency in the world can be compared to a worrying trend. The ‘greater fool theory’ states that the price of an asset is determined not by its intrinsic value but by the sentiments and expectations of market participants.
Many investors have become interested in trend following strategies in recent years due to the scars of living through two major bear markets since 2000. In my firm, we also believe in trend following as a sustainable method for managing the downside risk of investing in risky assets like equity index funds and ETF's.
Diversification can be an issue for traders with smaller account sizes. It can be incredible difficult to trade covered calls and create a diversified portfolio. For example, an investor with a $25,000 account would use up over half his capital doing one covered call on AAPL stock.
Many options traders seem to have a problem defining themselves. Repeatedly, we see traders describe themselves as conservative, using options primarily to hedge market risk. But … are they staying true to this definition.
Nothing can impact an investor’s success more than discipline. Warren Buffett noted that “the stock market is a device for transferring money from the impatient to the patient.” In studying the returns of various asset classes, JP Morgan made the startling conclusion that the average investor is the worst performing class:
I’m a big fan of the work of Cliff Asness and AQR (Applied Quantitative Research). Cliff was interviewed by Barry Ritholtz on his podcast. About twelve minutes in Barry asked Cliff what it means to be a quantitative investor.
Most traders are familiar with calendar spreads as a directionless trade that benefits from accelerated time decay for the near-term expiry position vs. the longer-dated option and benefits from volatility expansion. A "long calendar" spread is created when we sell the front month and buy the back month, getting a debit.
I've had few emails from people being assigned on positions and receiving margin calls, and generally not knowing what happened. I advise everyone to completely research and become familiar with the exercise/assignment aspect of option trading.
A good trade is one where you followed your process regardless of whether you made money or not. A bad trade is one where you didn’t follow your process regardless of whether you lost money or not. Amateur traders make one big mistake at the beginning.
Investing in bonds is considered a conservative way to hedge your falling stock trades.. Analyst and long-time market commentator Mark Hulbert noted this week that despite this past month’s price action, bonds are still a stock market hedge against stock market losses.
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