Optionetics Mentoring Program

We had our first mentoring phone call this week. We were a little apprehensive, not knowing exactly how this was going to work. We kept asking ourselves, if someone is that successful at options trading, why would they take the time to do over-the-phone mentoring. We hope that the answer is the mentors have a real desire to teach. Our call started a little late due to our mentor’s previous caller being completely clueless about using his computer. We went over some “housekeeping issues” such as names, addresses, e-mails, etc.; all information that they should have had and could have verified in a much more productive manner than taking up part of our mentoring time. We had e-mailed in a Pre-assessment Questionnaire earlier in the morning, but our mentor had not seen it yet. It would have been helpful if he had reviewed it before the call, but I didn’t give him a lot of time to do that. We went through the questionnaire item by item and he was very good at commenting, answering questions, and generally recognizing from our answers some of the issues that we may run into with options trading.

Trading Account
One of the first questions that I had was about setting up a trading account. We have all of our other investment accounts with TD Ameritrade, which rated high on the reviews on the Optionetics website. I had a little trouble setting up the account, because I was trying to set up a specific account, apart from our other investment accounts that we would reserve just for options (at this point). To set up an account that will allow for anything but the most basic options strategies you have to have a margin account. Because we already had a margin-enabled account with the same ownership, TD Ameritrade would not set up a second account. I considered opening up another account at another brokerage firm but realized that I could solve the problem by deactivating margin on our other account.

Most of the people I’ve talked with at Optionetics recommend OptionsXpress for a trading account. They have a different fee schedule from TD Ameritrade which makes it more difficult to compare apples to apples. TD Ameritrade charges $9.99 plus $0.75/contract (100 shares) while OptionsXpress charges $1.50/contract with a $14.95 minimum. That means that with all else being equal (which they’re not) TD Ameritrade is cheaper for less than 7 contracts. Probably more important than pricing, though, are the tools that each service offers. Unfortunately, at this point I don’t know enough to understand all of the differences. The nice thing that OptionsXpress offers that I would use right away is a Virtual Trading account. Our mentor suggested signing up for an OptionsXpress account, even if we don’t fund it, so that we would have access to the virtual account to try “paper trading”.

Money Management
It soon became clear in our conversations with our mentor that we are very interested in using options to reduce our risk. It’s one of my pet peeves when people compare trading options to stocks and say that with stocks you might earn a 5% gain while with options you would earn a 100% gain on the same trade. The only way comparing a 5% gain with a 100% gain is valid is if you are putting the same dollar amounts into each trade. It makes no sense when you consider the additional risks involved with options. While you might invest $10,000 in a stock, you would be foolhardy to put the same amount into an options trade. With options you can (and likely will) lose your whole investment on a good portion of your trades. That doesn’t happen very often with buying stocks. The key is to invest a much smaller amount in the higher risk options while putting the remainder of your investment capital in a risk-free investment. Our mentor suggested that Optionetics recommends not putting more than 5% of our account in one position. With a 50% stop loss, that limits our downside on that position to 2.5% of our account (unless the stop gets blown away, which is always a possibility). He thinks it’s better to limit the risk in any one position to 1-2%. He also recommends only risking 10-20% of our account at one time. That would imply 10 positions.

Limitations
As part of the Questionnaire we had to share a list of our limitations. We came up with the following. I felt that he had some good observations about many of them.
1. Somewhat risk-adverse. As we discussed above, there are strategies which will limit the downside-risk. He suggested that we might end up developing an “income style” of trading rather than working with “directional” trades. That is something that will come later on in the program, though.
2. Tend to focus on the losses rather than the gains. He suggested that many traders tend to pull the plug on winners too early and let their losers ride with the hope of the trade turning in their direction. Instead we should structure our trades with at least a 2:1 reward to risk ratio. That way even a 50/50 success rate will give us a profit. I still have somewhat of a problem with this concept because it only factors in the potential gain/loss, not the probability of each happening. You could structure a trade that has the potential to earn twice what it can lose, but have a greater probability that it will hit your loss target and still end up losing money in the long run. We’ll see how it plays out.
3. Tend to get caught up in the details. Details can be a very positive thing if it doesn’t lead to Limitation #4 below.
4. Tend to get immobilized by insufficient data. He called this “Analysis Paralysis”, which I thought was very descriptive. I have a hard time making decisions on incomplete information. I know I’m not alone in that. Unfortunately, there is seldom complete information when trading. As Don Worden has of Telechart has suggested, if you had complete information there would be no risk, and risk is what traders get paid for. The solution is to set up a trading strategy and stick to it.
5. Tend to be skeptical of strong, positive moves in the market. I tend to think that strong upward moves in the market mean that it is overpriced. Our mentor suggested that our job is to recognize what the market is doing, not to judge whether of not it is rational. The market regularly has strong moves that are not rational. We need to set up a strategy that will trade with the trend in the market, but be prepared to pull the plug if the market changes direction.