“Financial instruments of mass destruction” – Warren Buffett on derivatives
If I sit back to consider my trading strategies, it makes me laugh when I compare them to the mainstream. In my time as a New York stock broker, I remember being admonished constantly with the phrase: “90% of options expire worthless…” People tend to fear what they do not understand, or, in the case of Berkshire Hathaways, invest billions into these derivative products while advocating against them.
I find it all too common that people just don’t understand what options are and how they work. I remember my initial reluctance to risk money on these products. I was uncertain of what to expect, but I found it was easy to overcome my initial hesitation. Like entering a hot tub, I eased myself in.
image from abchottubexperts.com
I began trading in the stock market when I was quite young. I had just begun my undergraduate degree when I opened my first Ameritrade account. I read about various strategies and tried a lot of different things while taking copious notes. What I found, my number one issue was that I didn’t have enough funds invested to utilize any conventional form of risk management. In other words, most of this time was spent losing money and learning the hard way.
It wasn’t until I had begun my MBA that I confronted the topic of derivatives and options. I had become quite good with various forms of technical analysis, but my frustrations revolved around my attempts to minimize risk in a portfolio that was pathetically small. I couldn’t diversify well enough, because my positions would be too small for the returns (when I was right) to outweigh the transaction costs.
imaget from investmentyogi.com
I began paper trading different strategies utilizing the technical skills I had developed for trading stocks, and integrated options rather than the equities themselves. Over time, I found that I could maintain most of my funds in cash (risk free/highly liquid) as opposed to being fully invested at all times in equities. I could then take an occasional position, typically placing less than 10% of my account balance at risk, and earn exceptional returns. By paper trading these products, I quickly developed an understanding for how they worked in the real world and my confidence grew immensely.
I opened my first “real money” account for options after a full year and a half of paper trading and developing strategies I was confident would work. I was living in New York at the time, employed as a stock broker, and grew the account by 100% within 9 months. I hit these numbers due to sheer frequency of trading as I was watching the market daily. I do not believe, however, that I took on more risk than the average investor to hit these returns. I simply used a better vehicle.
image from liveyachting.com
In the coming weeks and months, I will be sharing my thoughts on risk management and the use of options contracts. It will be a repository of knowledge on this subject and a resource for traders looking to take the Quantum Option.
The Quantum Option 