Last Updated May 29, 2009 3:37 PM EDT
Advertisements like this are pretty irresistible. You combine "educational" and "free" -- one of my favorite words, by the way -- and you've got yourself a winner. Having attended some of those free seminars, I must say I've always been impressed by the presenters, though maybe not in the way they might hope. I'm actually impressed by the skill they employ to manipulate the emotions of the attendees in an attempt to get them to ignore all logic and buy whatever it is they're selling. Let me first explain how options work and why you might have better odds playing the lottery.
How Options Work
Options are a derivative security created from stocks. The "D" word alone should scare you. There are basically two main positions one can have, though derivatives of these derivatives are often touted. They are the call and the put. If you buy a call, you have paid for the right to buy a stock for a set price at a specified date in the future. If you buy a put, you are paying for the right to sell a stock for a set price at a specified date in the future.
For example, let's say that Exxon is trading at $70 a share today, and I'm of the opinion that oil is going up to $200 a barrel by Independence Day. I could buy a call to give me the right to buy the stock at $70 a share on the third Thursday in July. That would cost me only about $2.45 per option. In that way, instead of just buying Exxon, I could leverage my money and make significantly more.
Why Options Are Unlikely to Work For You
Who do I buy the call option from? I buy it from someone who thinks that oil is not going to go up, and wants to make $2.45 per option by selling me this call option. Note that the two of us are going to net zippo, no matter what the price of Exxon does by July. If it goes up, I'll make a bundle at the expense of the person who sold it to me, and if it goes down, I'll lose 100 percent of my $2.45 for every option I bought. What we have here is a zero sum game. Unlike the stock market, where everyone can win, in options no one can win in total before costs, and most will lose after costs. Well, actually, someone can win: the brokers who charge commissions to buy and sell these options.
Option trading companies will try to sell you on strategies of using options to protect your position or to generate income. These pitches all have two things in common:
- They're emotionally appealing, and
- They amount to a zero sum game before costs -- and a negative-sum game after costs.