Mark D. Wolfinger’s book The Rookie’s Guide to Options: The Beginner’s Handbook of Trading Equity Options (W&A Publishing, 2009) is perfect for the investor who is interested in writing covered calls and who might down the road consider some other options strategies. The rookie will still be a rookie after reading this book but, if he heeds Wolfinger’s words, he will not have committed a whole host of costly rookie errors.
Throughout the book Wolfinger describes options as more of a risk management tool than an outsized profit center. None of the “make 1256% in 5 days” hype. With any options strategy, he contends, it’s important to ask three questions: What do you have to gain? What do you have to lose? Can the strategy make a significant difference in the profitability of your investment portfolio? (p. 72) Where possible, he provides metrics to help answer these questions. For instance, a comparison of the Buy-Write Index (BXM) to the S&P Total Return Index (SPTR) shows that in wildly bullish times it’s better to own stocks outright. By contrast, in every year during the 1988-2003 period when the market returned less than 22%, BXM consistently outperformed SPTR. It’s worth noting that in the last five years this relationship has broken down. BXM underperformed in 2004, 2005, and 2006, the last year for which Wolfinger provides data. If my calculations are correct, the BMX outperformed in 2007 and underperformed in 2008. In brief, of late the strategy has been a little dicier to execute profitably.
Wolfinger acknowledges that covered call writing is not the best options strategy and recommends it primarily as a learning tool. Right here he may have given his best advice for the conservative rookie. I, and I assume most other investors, get countless invitations to investment dinners in which one of the most frequently advertised agenda items is “learn to make additional income month after month with covered calls.” The novice who is tempted to succumb but first wants a little more education might, after reading this book, take one step back. In fact, I would suggest that he try paper trading the strategy to gain a free education and to see whether it fits his risk/reward profile. Wolfinger provides all the basics for this education. He takes the rookie through the steps of preparing to trade, making the trade, and managing the trade.
Wolfinger then moves on to collars, which he views as the ultimate portfolio insurance policy. Whether or not one agrees with this thesis, the author serves the novice well by stressing the need to manage downside risk and providing one strategy for doing this. The final basic strategy that he discusses is writing cash-secured puts.
Although there are brief accounts of the Greeks and synthetics and although Wolfinger goes on to describe credit spreads, iron condors, and double diagonals, the strength of the book lies in the earlier chapters. He helps the beginner along with quizzes. On a bonus disc, he supplements the reader’s options education with a 25-question advanced quiz, some links, and articles he has written over the years for SFO magazine.