Investing using options is very different from constructing a classic long-term buy-and-hold portfolio.
In this segment from Motley Fool Live that first aired June 7, Motley Fool Canada analyst Jim Gillies and Fool.com editor/analyst Ellen Bowman discuss why easy wins early on might make for disappointed options investors later.
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Ellen Bowman: Number 5 is we stay focused. Talk to me about your crazy level of focus, Jim.
Jim Gillies: Car.
Bowman: [laughs] Right. Bird.
Gillies: Bird. What is it? The movie, Up, with the dog, "Squirrel." It's exactly what you just said there is that we started off saying writing a put. The stock went in the opposite direction that we were hoping for, bought the stock, turned into a covered call, turned it into a maybe another strategy. Call it stock repair. Stock repairs tend to be a lot more work for little gain, but you can do it. But the idea is that we focus on the business, so the market is going to go up, it's going to go down. A company can have a bad quarter. I think it was November 2016, 2015, I did a put write on a company called Shutterstock,(SSTK 0.70%), stock photography. I think maybe the virtual ink was just barely dry on the recommendation before the company released some really bad news, and the stock went from 62 to 26. That's not great. [laughs]
Bowman: Not necessarily what you were hoping for, sure.
Gillies: I was hoping that the stock was going to stay above 60 dollars, when it falls that far, Jim Mueller, if he's still listening will be nodding along because in 2011, of course he's Mr. Netflix, and he owns a lot of it in the past. How did that happen?
Bowman: But that's when I bought Netflix. I bought them at the Qwikster moment. They were my best investment by far. David Gardner recommended it, and I was like, "This man probably knows something about something." Anyway, Mueller had a slightly different experience.
Gillies: No, he bought and he's bought it before that too, but he had written some puts on it at about, I don't know. I think it splits subsequently, or maybe Jim will correct me if I'm wrong here, but basically, the stock fell 75, 80 percent. But he'd written puts up at the top end. Usually, when the stock falls and if you've got written put exposure, there are some things you can do to mitigate it and push out. But that's not generally the case. When a stock falls 75, 80 percent, you get to enjoy your new shares.
Bowman: Congratulations on your purchase.
Gillies: Yeah, you purchase that much higher too. Yes, the stock is 26 now, but you wrote the 60 dollar put, so you'll be paying 60 for your new shares. But when that happened to Shutterstock, and that's going to happen if you're going to play in the options pool, you're going to have this happen to you at some point. Hopefully early, so you get it out of your system and you learn how to deal with this stuff, because if you start getting cocky and you start always winning, that's the worst thing to happen to an options investor, I think. It's everything you touch turns to gold, and you get cocky and you get, "This can't hurt me."
Bowman: You can't imagine that would ever stop and then all of a sudden you find yourself in a position where you're way over-leverage that you can, just can't get a way out of it.
Gillies: Actually, Ellen, the keyword there is, I love that you brought up, is over-leverage. Because I guarantee you, if you are cocky and you think you can't lose, that is the moment when you lose.