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Options Are Not a Panacea

Under the current market conditions, I could see a FIRE saver being able to earn an additional 20% - 25% over and above their normal salary from dividends and stock and options trading. Unfortunately, the key phrase here is “current market conditions”. During recessions, dividends may stagnate or even be cut. Individual stocks can and do go into long periods of stagnation or decline. During periods of market volatility, it is easy to lose patience and sell at relative lows.


In contrast, periods of market volatility are good for options. Options pricing is best when people are evenly split on their prediction for the future price movement of a stock. Options are more of a zero sum game than most investments. More often than not, if you made money on an option trade, your counter party lost money. And, this occurred because you guessed the future price of the stock more correctly than your counter party. When everyone thinks the same thing about the future price of a stock, the options prices will adjust to the point where no one will make any money on a trade. If I buy a stock at $15 and have no expectation that it would go up to $17 within the next month (the options expiration date), any money I could get for a covered call at a $17 strike price would essentially be free money. However, if everyone else agrees with my assessment, there will be no interest and the bid for such a call would be $0.


So, when the stock market is moving steadily (up, down, or sideways), it is difficult to make money trading options. Everyone sees the same trend and will adjust their bids and asks for options contracts accordingly. On the other hand, this market condition makes it easier to make money buying and selling stocks, When stock prices are moving steadily upwards, just buy and hold stocks. When stock prices are steadily falling, short sell stocks. When stock prices are stable, buy stocks with the highest yields and collect the dividends.


During times of volatility, there will be a lot of diverging opinions on the future prices of stocks. Holding stocks could just as easily lose money as gain money. However, this divergence of opinions leads to better pricing for options contracts. You should be able to find attractive bids on call options at your desired strike prices.


In summary, when there is broad agreement about the future prices of stocks, it is hard to make money on options, but easier to make money on stocks. On the other hand, when there is no consensus the future prices of stocks, it is hard to make money on stocks, but easier to make money on options. While no single strategy can be used to make money at all times, using a combination of stock and options strategies should allow you make money in almost any market condition.

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