Wednesday, July 10, 2013

Wolfinger, The Rookie’s Guide to Options, 2d ed.

Those who have read the first edition of a book always want to know what is new in the second edition. So, before I look at the book as a whole, here’s a quick answer. In addition to the usual emendations and clarifications and a not-so-usual format change, Mark Wolfinger has added a chapter on calendar spreads and another on exercising (or, preferably, not exercising) an option.

Now that I’ve satisfied those who read The Rookie’s Guide to Options: The Beginner’s Handbook of Trading Equity Options when it came out five years ago, let me move on to write something for those for whom the book is an unknown quantity.

Option trading is an ever growing business as more and more investors seek to juice their returns. Perhaps I simply move in the wrong circles, but my sense is that retail investors are no longer using options primarily to protect their portfolios or to earn a little extra monthly income with covered calls. After all, the market has been trending up pretty strongly so protection hasn’t paid off and the Buy-Write Index underperformed the S&P Total Return Index by 11% in 2012. Many investors are instead succumbing to the siren call of leverage and short time frames. Why be content with a 20% return in a year if you can make that much in a week?

I guess one could call Mark Wolfinger old fashioned. After seven chapters that deal with “option essentials,” he devotes the next seven chapters—more than a third of the book—to basic conservative strategies such as covered calls, collars, and cash-secured puts. The final part of the book goes “beyond the basics” with discussions of the Greeks, European-style index options, risk management, and exercising an option as well as four additional strategies: credit spreads, iron condors, calendar spreads, and double diagonals.

If you are the type who views an option trade as a lottery ticket, if you are inclined to buy a far out of the money weekly call that could potentially yield a three- or four-digit percentage return but that is almost certain to expire worthless, this book won’t speak to you—at least not until you realize that you’re on a financially suicidal path. The reality is that every beginning option trader should learn the kinds of strategies Wolfinger describes even if he doesn’t plan to use them very often or right away. They can be quite useful when it comes to portfolio management, plus they’re excellent learning tools. Paper trade the basic strategies and, with Wolfinger’s tips on preparing the trade, making the trade, and managing the trade, start to learn how options really work. Soon enough you’ll be ready to move on to the more advanced strategies. Eventually, with study and practice, you’ll no longer be a rookie.

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