Interview: Ray from Financial Highway

Today, we interview Ray from Financial Highway. Ray has been involved in the investment industry for a number of years now and this interview is focused on financial advisers and what you should know about them. Please consider subscribing to his feed.

Here is the interview.

Q1. Who should think about getting a financial adviser? Is it just for the wealthy or can anyone use the services of a financial adviser?

That is one of the most common questions I have been asked, and there really is not a right or wrong answer. There are many different “types of financial advisers”, so pretty much anyone can benefit from one.

It comes down to many things; how much experience does the investor have? Are they looking just for investment advice or a comprehensive financial plan? Do they have a large sum to invest or small amounts? Prefer passive investing or more active trading?

Also remember; there is always a cost associated with financial advisers either through fees or commissions, so there must be enough reward for the added cost. For example if you have a decent size portfolio and decide to go with a discretionary portfolio manager (you give the manager the authority to trade on your behalf without your consent within your risk profile) you should get a better result, than if you had just purchased some index funds and ETFs to justify the extra cost.

Anyone can benefit from a financial adviser, not just the wealthy. But benefit doesn’t always mean the best option or result. One could benefit from a financial adviser, but the added cost can negate those benefits. If the investor is a novice investor and does not understand the financial markets, then an adviser can be of great help, but if the investor has a decade of experience in the financial markets and has a good understanding of investing, the adviser might not be beneficial enough to justify the costs.

I think Financial Advisers can be of great value but finding a good adviser is not always easy. To make it a little easier I have a list of questions to ask a financial adviser before hiring.

Q2. How does a financial adviser make his living and is there any conflict of interest between him and his customers?

Ah conflict of interest of a financial adviser, how often do we hear this? Well, first of all there are generally 3 ways advisers get paid.
1. Sales commission: That’s when an adviser sells you a security (stock, mutual fund, bond) and gets a sales commission.
2. Fees: There are fee-based advisers who charge a fee, either hourly or per task, and you will have to do your own investment purchases.
3. Asset based. They charge a certain percentage of your assets under management per year, generally the larger your portfolio the lower the percentage annual fees charged.

As you can guess there can be a substantial amount of conflict between commissioned advisers and clients. They could trade more frequently than needed to increase their revenue. In fact, this is so common it has a name: churning. They could recommend investments mainly because of higher commission payout, even though there may be cheaper options. These are just two conflicts out of many potential. It’s not that all commissioned advisers are bad; you just have to be more careful with your options and monitor things a little better. I have a more detailed post on Investment Advisor’s Conflict of Interest.

Q3. When someone approaches a financial adviser for the first time, what are the questions that they should ask?

First of all, if you are looking for a financial adviser; do not settle for the first one you find. Shop around; find a few, do a little research on the firm and then interview them.

Top 3 questions to ask would be:

1. How often have you changed firms and how long between each firm change?
This is especially important if you are speaking with a commissioned based adviser, commission based advisers tend to change firms frequently because of higher payouts offered at other firms. If you notice they have changed too frequently (depending on the experience, but I would say more than 3 times) can be a sign of danger. Also if their stay with each firm has been too short I would look elsewhere.

2. What other services do you and your firm provide?
You’d want to know if the adviser/firm tries to go out of their way for their clients, do they offer insurance? tax and estate planning? mortgages? The more services they provide the more client-centric they will be.

3. Can you provide me with 3 references?
The best way to find good advisers is through referrals; ask friends and family if they have a good adviser. If you are interviewing an adviser whom you have not been referred to, then ask for references and then call and speak with them and ask about their experiences with the adviser.

Asking for referrals is much more powerful than any number of questions you ask the potential adviser.

Again I point you to my list of questions 14 questions you should ask an adviser before hiring.

Q4. What kind of things should cause you to worry about whether you have the right financial advisor or not?

That is an excellent question and with this financial crisis many people are wondering if they had the wrong adviser.
The first thing that should always cause you to reconsider your current adviser is CONTACT! If you do not hear from your financial adviser at least every six months and do not sit down at least annually, then you have a major concern. A good adviser checks in with clients on a regular basis, not only to make new sales, but to ensure things have not changed dramatically or if the clients have any questions. I personally would contact my clients once every quarter by phone and meet face to face every six months and none of those contacts would be solicitations.

Other things would be if you notice regular errors on your statements, mistakes happen, but if you notice regular errors there maybe something going on which is worth an investigation.
Frequent trading, if the adviser constantly trades, I recommend you take a closer look at the reasons for the trades.
These are just a few things (out of many) to keep in mind.

Q5. Finally, a lot of blame has been put on the financial advisors for losing a lot of their customer’s wealth in this current meltdown. What are your thoughts on this?

I agree, Financial Advisers have come under scrutiny by their clients. It is natural to want to blame someone when things go wrong, and investors have turned to blame their adviser, but its part of the job. This is where you can distinguish the good advisers from the bad ones.

A big part of an adviser’s duty is to educate the client and to keep clients emotions out of investing. It is not easy talking to clients and telling them they have lost 40% of their portfolio and that they should invest more, but that is exactly what a good adviser should tell their clients. Unless you have had an unethical adviser, there is no way an adviser could have predicted this mess (well hardly anyone did) so it’s not the adviser’s fault that the markets lost 40% last year, blaming them does not make any sense. As long as your investments reflect your risk profile you should not blame your adviser for the losses.

I really enjoyed doing this interview and would like to interview other bloggers as well. If you are interested, please get in touch with me using the contact form.  I hope readers found this good too, please leave comments to let us know.

Upcoming Interview: Ray from Financial Highway

Tomorrow there will be an interview with Ray from Financial Highway.

Ray has been involved with the investment industry and there will be questions on conflicts of interest between a financial adviser and the customer (my favorite), questions to be asked, when seeking an adviser and who should get a financial adviser (among others).

Ray gave some candid answers, which were very interesting. Please come back for the interview tomorrow and see for yourself.

This will be the fourth interview in our series, which started with Weakonomics, TIE and then Mark Wolfinger.   I really enjoy doing these interviews, and if other bloggers are interested, please contact me using the contact form.

India ETF List

After the gold ETF list, oil ETF list and silver ETF list, next in line is the India ETF list. Strictly speaking, there are just two ETFs that focus on Indian equities.

There is one ETN that focuses on Indian equities, and then I included an ETF that invests in Indian and Chinese equities.

Here are all the funds:

Wisdom Tree India Earnings Fund (EPI): This India ETF invests in Indian companies that are listed on a major stock exchange in India and meet the following criteria:

  • Have generated at least $5 million in earnings in the last fiscal year.
  • Have a market capitalization of at least $200 million.
  • Have an average daily dollar volume of at least $200,000 for each of the six months prior to the Index measurement date.
  • Have traded at least 250,000 shares per month for each of the six months prior to the Index measurement date.
  • Have a price to earnings ratio (“P/E ratio“) of at least 2 as of the Index measurement date.

PowerShares India Portfolio (PIN): This India ETF seeks to track the Indus India Index (before fees and expenses). The index in turn is designed to replicate the Indian equity markets as a whole, through a group of 50 Indian stocks selected from a universe of the largest companies listed on two major Indian exchanges. The India Index has 50 constituents.

iPath MSCI India Index ETN (INP): This is an India ETN and not an ETF. This India ETN tracks the MSCI Total Return Index, which is an index that represents approximately 85% of the free-float-adjusted market capitalization of equity securities by industry group within India. As of March 31, 2009, the Index was comprised of 59 companies listed on the National Stock Exchange of India.

First Trust ISE Chindia Index Fund (FNI): This is not an ETF solely focused on India. It invests in the ADRs, ADS or stocks of companies both in India and China. It has 50 holdings and the biggest holding is Infosys Technologies with 8.01% and the second biggest holding is China Life Insurance Company with 7.74% as on March 31st 2009.

Direxion Daily India Bull 2x Shares (INDL): This is a daily leveraged ETF that seeks daily investment result of 200% of the performance of the Indus India index. This is a 2x leveraged fund that seeks daily returns. You can read about leveraged ETF funds here.

Direxion Daily India Bear 2x Shares (INDZ): This is also a daily leveraged India ETF that seeks daily investment returns, but in opposite direction of the Indus India index. The 2x leverage daily returns means that it is not suitable for someone wanting to hedge their portfolio over a long term, and is at best an active management tool that can be played for the very short duration.

iShares S&P India Nifty 50 Index (INDY): The iShares S&P India Nifty 50 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the S&P CNX Nifty Index. It has an expense ratio of 0.89%, and the Nifty is one of the most popular indices in India.

EGShares India Small Cap (SCIN): The Emerging Global Shares Indxx India Small Cap Exchange Traded Fund (ETF) seeks investment results that generally correspond (before fees and expenses) to the price and yield performance of the Indxx India Small Cap Index. The index is a freefloat market capitalization weighted stock market index comprised of a representative sample of 75 Indian companies that Indxx, LLC determines to be the representative of small market capitalization companies domiciled in India. This fund is new and has limited operating history.

EGShares India Infrastructure (INXX): The Emerging Global Shares Indxx India Infrastructure Index Exchange Traded Fund (ETF) seeks investment results that generally correspond performance of the Indxx India Infrastructure Index. The Indxx India Infrastructure Index is a free-float market capitalization weighted stock market index comprised of 30 leading companies that Indxx, LLC determines to be representative of India’s Infrastructure industries, as defined by the Industry Classification Benchmark(ICB).

Photo Credit: Marko Belluci

Update: Included the Direxion Leveraged funds and iShares S&P India Nifty 50 on May 09 2010.

Second Update: Included the EGShares India Small Cap and Infrastructure ETFs on Sep 12 2010.

Interview: Silicon Valley Blogger from The Digerati Life

I am a big fan of Silicon Valley Blogger (SVB), who runs The Digerati Life and The Smarter Wallet. Last week, she did an interview with Ask Mr. Credit Card, and I liked it very much.

My first thought on seeing the duration of the interview (1 hour) was that it is just too long, and there is no way I will be able to listen to the whole thing.

It took me about four sessions, and it was so good that I felt compelled to listen to the whole thing. The interview bends towards the personal side of SVB, so I think people who are regular visitors to her site will really like it.

I am not sure how others will find it, but, if you like The Digerati Life and missed the interview for some reason, or didn’t start listening to it because 1 hour felt too long, then I think you should listen to this now.

Interesting Reads June 27 2009

Last week, I accidentally deleted the wittiest comment I ever got. I spoke about chess in my post, and DR posted a comment, which said:


I thought he didn’t mean to write that, and it was a typo or something. So, I went ahead and deleted it. Later on, I emailed him saying that I deleted the comment and he responded saying — he was making the first move!

You see, in Chess notation, “e4” would be the King White Pawn moving two squares forward.

I felt quite silly about the whole thing, and I haven’t even deleted any spam since last week.

Now, on to the smarter things written by fellow bloggers this week:


Of Black Swans and Put Options

Nicholas Taleb is famous for his black swan concept, and also for making a lot of money when everyone else is losing it.

So, I was intrigued to read this piece by Janet Tavakoli via Market Folly.

It says:

A recent GQ article quoted Nassim Nicholas Taleb as saying that in the falling market he “made $20 billion for our clients, half a billion for the Black Swan fund.” 1

I checked with Nassim Taleb regarding the $20 billion in gains and asked if he were misquoted. He responded via email: “The quote is inaccurate. THe [sic] 20 billion might correspond to the face value of positions.” This response is both vague and different in character from the mythical $20 billion in gains inaccurately quoted in GQ‘s article. The total gains could be a tiny fraction of what Taleb loosely describes as “face value.” 2….The black swan fund’s strategy is purportedly to buy out‐of‐the‐money put options on stocks and broad market indices and hedge tail risk for clients. The strategy may produce long periods of mediocre-or even negative-returns followed by a large gain and vice versa. No one can tell you for certain exactly when (or for how long) large gains are possible. Initial success in a newly created fund may not be replicated in the future, and there is always the problem of scaling. Scaling refers to the fact that an individual fund may make a high return on an initial investment, say 100% on $100 million, but lose 10% on $1 billion.

I first read “Fooled by Randomness” by Taleb, about a couple of years ago and wrote a post about probability v expectations and gaining from big crashes in the markets.

The idea is that you position yourself to gain from the spectacular crashes that are bound to occur once in a while, and so buy “cheap” put options in that anticipation (like the black swan fund strategy).

Here is what I thought at that time and is still valid:

I have heard my dad telling me once that these market crashes are inevitable and every month one should buy a ‘cheap’ PUT so that when once in a year the market falls spectacularly that PUT is worth a gold mine and covers up for all the remaining 11 months when the market followed its due course. He was talking about low probability and high expectation and I think a lot of investors do think about this but not really do anything about it.

I myself have never tried buying PUTs hoping that the market crashes and certainly do not recommend it to anyone but it is certainly a thought that is worth a thought. And while one is at it why not buy a ‘cheap’ Call as well just to take care of the ridiculous 1000 points upward moves too!

I never did carry this thing out and I am glad I didn’t do anything like that because although I did anticipate that there will be long periods of no gains, from the performance of Taleb’s fund, it looks like even when the black swan appears – you are not guaranteed to make a killing.

Photo Credit: Ennor

Dow Jones Industrial Averages: Mythbusters edition

I wrote a post over at the Dough Roller about how the Dow Jones index was calculated, and the Finance Nerd left a great comment with a link to a Stanford Paper written by John B. Shoven and Clemens Sialm, which busts some myths about the Dow Jones Industrial Average (DJIA).

But, first a little background on how the index is calculated.

Calculation of Dow Jones Industrial Average

Unlike other major indices, the Dow Jones index is based on simple price averages and doesn’t take into account market capitalizations.

This means that the index is calculated by adding up the price of its 30 stocks and then dividing it by 30.

You are probably thinking that if you just add up the price of 30 Dow stocks and divide it by 30, the resulting number can’t possibly be the 8,300 or so, which the Dow is currently trading at.

You are right, and the reason it has reached so high is because it is divided by a number called the “Divisor”, which takes into account — stock splits and dividends. The divisor was invented to make sure that dividend and bonuses don’t impact the index. Discussion about the divisor can get a little involved, and if you are interested in the Divisor, head over to this post.

The other curious thing about the DJIA is that it is composed of 30 stocks selected by the editors of the WSJ. It is not an index of the 30 largest companies, as a lot of people think it is. The editors at WSJ have the freedom to pick and choose between stocks, and they select the best options (in their mind) to represent the overall economy.

Given these facts, let’s head back to the research paper.

There are three things that the paper examines about DJIA and much like Mythbusters, run their tests to see whether they are busted or not.

Myth 1

  1. It is too simplistic, so it must be flawed: The index is based on price weights, instead of the other superior methods like market capitalizations. That means a stock which has a higher price has more weight in the index, than a stock which has a lower price (regardless of the size). This should render the index quite flawed.

To test this myth – the researchers constructed a Dow Jones index that was value weighted (based on market capitalization) and compared it with the original index. The results are quite astonishing.

The actual DJIA stood at 239.43 in October 1928 and closed at 9,181.43 on December 1998. The value weighted index that was equal to 239.43 in October 1928 would have closed at 9,842.37 points in December 1998. They compare the monthly returns between the two indices and while the value weighted index outperforms the DJIA in 422 months out of 843, DJIA outperforms it in 421 months. The correlation between the two return series is 0.9778.

As far as I can see, there would have been very little difference between the value weights and price weight Dow, and this myth is busted.

Myth 2

The stocks are selected subjectively, so it must be flawed: The stocks that go to make the index are selected by the editors of Dow Jones and there are no set rules on the entry to this index. The editors decide which stocks will best represent the economy and then include them in the index. You can see that this is quite arbitrary and it leads you to believe that the index must have flawed results.

The researchers construct these hypothetical indices:

  • Value Weighted Dow: Same thing we talked about earlier
  • Value Weighted Big 30: Index of 30 largest publicly traded companies in the US from 1928 – 1998.
  • Value Weighted Total Market Index: Index of all US Headquartered securities, which had over 8,000 companies in December 1998.
  • And S&P 500

(They also use something called as Equal Weighted Index for calculation, but I am not including it here because it is pretty flawed itself, and doesn’t add much by way of comparison)

The researchers normalized these indices to start at a value of 239.43 on October 1928, and this how the indices fare:

  • DJIA: 9,181.43
  • VW Dow: 9,842.37
  • VW Big 30: 11,211.32
  • S&P 500: 13,776.55
  • VW – Total Market Index: 12,141.95

As you see, the gap widens up, and looks like the Dow has actually underperformed the broader indices. This one presents no clear answers, so I leave it to you to decide whether this flaw makes any difference or not.

Myth # 3

This is the greatest part of the paper. Since stock market returns are used to gauge returns to investors, leaving out dividend payments doesn’t truly tell you how much investors made from the markets. So this is a serious flaw, which all other major indices share with DJIA.

The paper constructs a value weighted Dow Jones index that includes Dow Dividends and guess where it would stand in December 1998?

233,060 points!

So, if you were to include dividend payouts, the index would have been 25 times of what it was!

Don’t even need to say who won this round.


This is a great paper, which examines some commonly held notions, tests them against data, and then comes up with some unexpected answers. At 16 pages, it is a relatively quick read and if you liked this post, you should definitely give it a try. You can download it at this link.

Photo Credit: kwc

Will you choose sincerity or brilliance?

Image by Davic

I used to be a star performer in your team till a couple of years ago, and then I got lazy. I worked in sales and broke into some major accounts. As a result, my bonus payments grew and even though I didn’t make any new sales, my old breakthroughs meant that I bagged a comfortable salary every year.

This bag of green made me a little complacent and it’s apparent to everyone, that I don’t give more than 50% to the job now. I am here because I did some good things in the past, and the old – timers like me.

The new people in the team hate me because I come to work at 10, leave at 4, while they come at 8 and leave at 8. To them, I am free riding on their efforts. To me, if it weren’t for my breakthroughs, these guys wouldn’t have a job in the first place.

To the management, as long as the money comes in, they don’t care. But, the money stops coming in. The recession hits, and suddenly there is surplus staff. Corporate sends you a memo asking you to identify one person from your team who can be fired.

Everyone knows about the memo and you can observe that there is a spurt in everyone’s productivity. Even I am reaching work at 7 and hardly ever leave before 9. I make almost double the sales calls, I used to, but because of the bad market, I am not able to make any sales.

The other guys in the team are working hard as usual, and are quite happy that you will get rid of me now and their hard work will pay off (because their job has been protected).

You are in a dilemma because you know that I have the potential of being a fire-cracker and with my renewed energy, I could break into more accounts. The other guys, while being sincere, never showed any promise of getting any major breakthroughs.

I am brilliant but insincere, while they are sincere, but not brilliant.

Will you choose sincerity or brilliance?

Disclaimer: I am neither brilliant, nor sincere in real life.

Interview: Options for Rookies

I am happy to present my interview with Mark from Options for Rookies. I wrote a brief intro about him yesterday, which can be found here, and I know that readers are always looking for useful e-books, so I want to point you to two free e-books from Mark, one is a rookie’s guide to options and the other is a book about basics of options.

Please consider subscribing to his feed, and here is the interview.

1. Your site is named — Options for Rookies, but are options really meant for rookies? Isn’t the average investor, who invests in passive funds, better off staying away from options altogether?

This is quite a question.  It gives me so much to say about topics that are important to me.

a) When I use the term rookie, I’m referring to people who already have some investing experience, but are new to options.  I do tell an investment rookie that lack of stock trading experience should not make it any more difficult to understand how options work – but the trading aspects of investing have to be learned from the beginning.  I write, based on the assumption that the audience has experience with the stock market.

b) I don’t accept your premise that the average investor invests in passive funds.  The mutual fund industry, composed of actively managed funds, and which employs a huge sales force to encourage individuals to entrust their money to those active fund managers, controls far more money than index funds or exchange traded funds (ETFs).   I honestly believe that passive funds are much better than actively managed funds for the vast majority of investors.  But there is a large group of people who enjoy making their own investment decisions.  Some trade in and out of mutual funds, trying to time the market  or find the ‘hot’ fund manager (a very poor methodology, in my opinion).  Many short-term traders use charts (technical analysis) to make trading decisions, and some love picking their own individual stocks.  The data has been collected and studied and tells us that those who trade actively, picking stocks and funds, perform worse than those who trade less often.  Part of that decreased performance comes from paying commissions.  Active trading may not translate into more profits for the average investor, but they continue to trade actively, nonetheless.

c) The final part of your question represents a view I see (too) often.  Why do you take the stance that staying away from options would be a good thing for investors?  Did you know that options were invented (centuries ago) as risk-reducing investment tools?  That’s how I teach people to use options.  I only recommend strategies that are less risky than owning stocks.  By that I mean, when the stockholder loses money, the option trader who is long the same security either loses less money, or earns a profit.  When the stockholder earns a small profit, or perhaps owns a position that is nearly break-even, the options trader earns a profit.  The option trader outperforms the stockholder in the vast majority of situations.  With conservative strategies, the only time the stockholder does better occurs when there is a large increase in the stock price.  Yes, that happens, and that bonanza possibility is what makes investors try to pick their own stocks.  The options trader, with his limited profit positions may feel short-changed when those large gains are being made by everyone else, but those surging markets don’t occur very often.  Depending on the option strategy chosen, the option trader always loses less when the market moves against the stock trader, always makes more profit when the markets are stagnant, and outperforms in a rising market – but only up to a certain point – because profits are limited.  How can that not be considered conservative?  Why wouldn’t that scenario be attractive to the average individual investor – if only he/she were made aware that this opportunity is available.

But as badly as he/she may feel during surging markets (the technology bubble of the 1990s, for example) think how much more relieved they are to avoid the massacres that occurred when that bubble burst or in the 2008 – early 2009 bear market.  The protected, hedged investor is better off.  And that’s why I disagree with the premise that passive investors would be better off without options.  The evidence is strong that they would be much better off by adopting options strategies.  But, there are financial planners, and personal finance writers – both in the blogosphere and the national press – who stress the same stuff year after year: the importance of diversification, asset allocation, continuing to invest during bull and bear markets – that it’s impossible for an investor to find an opposing view.  That minority view is mine:  options reduce risk.  Options are advantageous for both passive and aggressive investors.

I don’t understand why ‘staying away from options’ is considered to be the norm when any intelligent investor ought to want to learn about options and how they work – and then decide if using options is appropriate.  But they never go that far.  Options are just dismissed from consideration because they appear to be risky and made only for speculators, because they get bad press when a rogue trader loses billions for a bank.  Options are not for everyone, but any conservative investor who likes the idea of preservation of capital can do well with collars, or other option strategies.  Too many investors gamble with options and get wiped out.  But, that’s the result of gambling, not of using options.

2. You talk about trading in options conservatively. This is the first time I have heard the two words — conservative and options in the same sentence. How can someone trade in options conservatively?

As I said earlier, options were designed to be conservative tools.  Just because many investors use options to gamble does not make options risky.    The fact that too many people adopt option strategies for which the odds of success are stacked against them does not make options trading risky.  It just means that too many option traders decide to gamble with options and not reduce risk.

Options trading is conservative because it reduces the risk of investing in the stock market.

When adopting my favorite strategies, compared with the stockholder, the option trader

  • loses less often
  • loses less when a loss occurs
  • wins far more often
  • and only occasionally performs worse than the stockholder

Option trading can also be combined with passive investing.  I’m sure most people who believe in passive investing own shares of a fund that  mimics the performance of the S&P 500 Index.  Well, an option trader can also build a position in that passive index – without owning shares.  By using options, the trader can hold a much less risky, but still passive, investment than the fund owner.  The word I have not yet used is ‘hedge.’  To hedge means to ‘reduce the risk of owning.’  That’s what options allow the investor to do – invest with less risk.  Just because an investment is passive does NOT mean it will do well.  The year 2008 illustrates that even passive investing can be dangerous.  But the option trader who owned shares in SPY (the ETF that mimics the S&P 500) could have hedged risk and as a result, not incur the large losses of the average (so-called prudent) investor.  Everyone thinks investing in the market is a good, wise, and prudent thing to do.  Most of those same people think trading options is risky.  That’s just wrong.  Options can be used to reduce risk – and should be so used by the majority of investors, not by only a small minority.

That’s my definition of being conservative with options.

3. What is the best way for a rookie to start trading in options?

When it comes to trading I don’t ever like to use the word ‘best.’  Each investor has his/her individual comfort zone that must be satisfied when trading.

But to me, the right method for beginning is to read.  Learn how options work.  Here’s a link to some of the most basic concepts about options.  Options are simple, not complicated.  In this country, if you go to a store to buy something offered at a special price, when the store is out of the item, the customer is given a rain check that allows him/her to buy that item (when the store has more of them) at the same price for a limited time.  That rain check is a call option.  Options are just that simple.  A call is the right to buy at a given price for a limited time.  Equivalent to a store’s rain check.  Strategies may be simple or complex, but options are very easy to understand.

After having an understanding, practice trading with play money, or if you must, use real money – but trade a small amount of dollars until some hands-on experience makes you feel more comfortable.  Keep reading.  Keep learning.  Do not assume options are the path to instant riches.  They are not.

And have patience.  You have the rest of your life to trade.  Learn and understand first.

4. What are some trades that a rookie investor should stay away from?

That’s easy.  Any trade you don’t understand.

If you don’t know which expiration date to chose, if you don’t know which strike price, if you don’t know whether the options you are buying or selling are trading at a fair price or are either a bargain or way over-priced, then do not trade.

And more importantly, if you don’t know know how the price of your option(s) will be affected when such and such occurs in the marketplace, you cannot trade.

Don’t trade if you don’t know how much money you can lose on the trade.  Or what your profit target is.  Or what has to happen for you to earn your target profit.  If you don’t yet understand how they work, don’t trade options.  It’s unbelievable how many investors think there’s nothing to it, jump right in, and lose all their money.  All that without the slightest idea what they are trying to do.  It’s because of traders such as these that options are not considered to be a conservative investment tool.

5. What are some good ways to hedge your positions using options?

There are many possibilities because options were designed to hedge, or reduce risk.

In no specific order (and some of these I don’t recommend), to hedge a long position, an investor can sell a covered call, sell extra calls, buy a protective put or buy extra puts, sell a call spread, buy a put spread, own a collar position (buy a put and sell a call).  There are other choices.   I hope no one would consider making any of these trades without further information.

This was the third interview in our series, which started with Weakonomics and then TIE. I really enjoy doing these interviews, and if other bloggers are interested, please contact me using the contact form.

Upcoming Interview: Mark from Options for Rookies

I am happy to announce that tomorrow there will be an interview with Mark, from Options for Rookies. I have been following this blog for only a short period of time, but I still think, if you want to get started on options, this is a good place for you.

Here is a brief intro about Mark, in his own words.

I was a CBOE market maker for 23 years.  For the past 9 years I’ve been an educator of individual investors, stressing conservative uses for options.  I published three books – all for option beginners, and the latest is The Rookie’s Guide to Options. I’ve been writing a blog for one year and a web site for about 7 years. I was born in Brooklyn NY, went to Brooklyn College, and then the Northwestern University (PhD in Chemistry).

Check out the interview tomorrow, and before you leave, I want to point you to a review of the book that Mark mentions. Click here to read the review.