Understanding ETF Options: Profitable Strategies for Diversified, Low-Risk Investing (GENERAL FINANCE & INVESTING) - Hardcover

TRESTER

Hardcover

ISBN 10: 007176030X ISBN 13: 9780071760300

Publisher: McGraw Hill, 2011

Synopsis

Proven ways to increase profits while reducing risk in one of today’s fastest growing markets

Finding a safe investment in today’s markets makes looking for that needle in a haystack seem easy. With a single whale able to move a market, herds of elephants ready to stampede after it, and a global computer network executing high-frequency trades in milliseconds, an investor might think stuffing cash under a mattress is safe financial planning. But those dollars have lost about 40 percent of their buying power in the last 20 years.

Understanding ETF Options is the best way to protect and grow your assets in the financial climate ahead.

This hands-on guidebook gives you a unique audience with options expert Kenneth Trester, who has traded on the exchanges since their inception in 1973. This book culls his experience in systems analysis, operations research, and investment management to help you diversify risk while profiting on market volatility.

Through conversational explanations and real-world examples, it lays out how ETFs offer retail investors easy access to diversified financial value and demonstrates effective techniques to acquire, safeguard, and accrue wealth by trading options on these unique securities.

Whether you are an experienced investor or have never executed a trade, Understanding ETF Options can get you up and running on the exchanges with confidence and control. It comes with such essential tools as the Fair Value Option tables and covers everything you need to know to trade ETF options successfully, including:

• An insider’s explanation of ETFs
• How to identify valuable ETFs
• How to avoid rogue waves
• Strategies for achieving your goals among the elephants, whales, and computers
• Professional traders’ secrets for option buying and writing

As far as options are concerned, everything comes down to time and movement. Now is your time to make a move and put your future wealth into your own hands with Understanding ETF Options.

About this title

About the Author

Kenneth R. Trester is recognized as a leading international options advisor. A popular speaker at financial conventions and options trading seminars, he is credited with originating many of the options strategies that are industry standards today. He is the author of The Complete Option Player, 101 Option Trading Secrets, Sure Bet Investing, and The Option Player’s Advanced Guidebook.

Excerpt. © Reprinted by permission. All rights reserved.

UNDERSTANDING ETF OPTIONS

Profitable Strategies for Diversified, Low-Risk Investing

By Kenneth R. Trester

The McGraw-Hill Companies, Inc.

Copyright © 2012 The McGraw-Hill Companies, Inc.
All rights reserved.

ISBN: 978-0-07-176030-0

Contents

Introduction
Part I: Recognition of Obstacles The Right Attitude
1. Rogue Waves
2. Avoid Wall Street Pitfalls
Part II: The ETFs = The Assets
3. Exchange-Traded Funds (ETFs)
4. Master Limited Partnerships (MLPs)
5. Real Estate Investment Trusts (REITs)
6. The Danger of ETFs
Part III: Recognition of the Elephants, Whales, and Computers = Defensive 
Measures
7. Elephants and Whales
8. Diversify, Diversify, Diversify
9. Contrary Investing
Part IV: The Options = The Tools
10. Options Made Easy
11. Playing the Odds
12. Secrets to Successful Option Buying
13. If You Are a Bear, Be a Grizzly
14. The Secret Path of the Professional
15. Thinking Like the Professionals
16. The Secret to Buying Low and Selling High
17. The Win-Win Strategy
18. The Art of Valuing Options
Part V: The Portfolio = Holding And Hedging
19. Long-Term Investments Are Dead, or Are They?
20. Develop Your Own Hedge Fund
21. The Perfect ETF Portfolio
22. Are You a Gunslinger?
Part VI: The Best Move = The Win-Win Strategy
23. Put Writing with Insurance
24. In Search of the Sure Thing
25. Pep Talk for Option Writers
Part VII: The Mission = Success
26. In Search of the Holy Grail of Investing
27. The Mission
Appendix: The Fair Value Option Tables
The Normal Value Listed Call Option Tables
The Normal Value Listed Put Option Tables
Index

Excerpt

CHAPTER 1

Rogue Waves

The phenomenon of rogue waves shows you why the environment is dangerous and howprecautions must be in place. Rogue waves are ocean waves that are about 100feet high. Such waves based on linear models should occur only once every 10,000years, but based on recent historical observations, these waves may occur moreoften. Some have even hit cruise ships. One ship disappears every week in theocean. Once thought to be caused by human error or mechanical failure, many ofthese disappearances are now blamed on rogue waves. Rogue waves can appearanywhere in the oceans without warning.

We see the same phenomenon in the investment markets. Rogue waves hit stocks allthe time. These waves are unexpected news events. Such events cause stocks toleap up or drop down in price.

The book The Black Swan by Nassim Nicholas Taleb (Random House, 2007)helps explain the impact of improbable events. Black swans were thought not toexist until they were discovered in Australia. Today the term refers to highlyimprobable events, and the book indicated that these events occur much moreoften than you would expect and that they can have a dramatic effect.

Furthermore, chaos theory indicates that small changes can have big impacts.This is also true of the markets. In other words, certain events, even smallones, can have a dramatic impact on the daily markets today. When we see theseimprobable events, most people call them black swans, but because of the havocthey can wreak, I call them rogue waves.

An Example: Subprime Mortgages

An example of a rogue wave is the severe recession of 2008–2009. One ofthe major causes was the subprime mortgage bubble. Part of that problem was thatthe rating agencies were giving all these subprime mortgages a triple A rating.One of the reasons that these agencies were giving these AAA ratings to subprimemortgage packages, which were purchased all over the world, was that theirmodels for determining the ratings had a worst-case scenario of a decline inreal estate prices by only 15 percent. Unfortunately, what we saw was a declinein real estate prices by 40 percent, something totally improbable, but again oneof these rogue waves.

Defensive Moves

In such an investment environment, it is critical that you make investments thathave a lot of upside gain and minimal downside loss. Here, options are theanswer. The option market is one of the places where you have greater safety toparticipate in the market. Also in options, diversification is necessary, andETFs will help you diversify.

An important lesson learned here is that you need to make an honest appraisal ofthe worst thing that could happen to an investment that you are consideringmaking. It is always more important to know the worst-case scenario rather thanthe best-case scenario. This is a key element in determining whether you will bea successful investor or not. This factor also tells you to be well diversifiedand to seek some protection in the options you buy so that rogue waves do notcause your major investments to tip over and sink out of sight forever.

CHAPTER 2

Avoid Wall Street Pitfalls

In the movie Wall Street, the main character, Gordon Gecko (played byMichael Douglas), made a pronouncement that you should always remember. "Moneymanagers cannot beat the S&P 500 index because they are sheep, and sheep getslaughtered."

Don't Follow the Money Managers

Not following the money managers makes a lot of sense. If we go back to the1960s, mutual funds and money managers have had a difficult time beating theaction of the S&P 500 index. In fact, numerous studies over the years havedemonstrated that 80 percent of the managed funds have been unable to beat themarket. (The difficulty of beating the market is probably why so many moneymanagers leave the profession.) Actually, money managers are not sheep, but theystill have a very difficult time beating the market.

The big question is: why are the best professionals on Wall Street not able tobeat the market? One reason is that we are faced with a very efficient market.With computers becoming almost as intelligent as people and with an ever-increasinglarge number of skilled professionals analyzing stocks, mostinformation about a stock is already in the market, and the price of a stockreflects all the information that is currently available to the public.

Don't Underestimate the Wisdom of a Crowd

There is another reason the market is so efficient—a smart crowd. Forcommanders, underestimating the enemy can be fatal. General Robert E. Leeunderestimated the morale and skill of the Union forces at Gettysburg, and hisarmy was defeated. General Ulysses S. Grant underestimated the strength of theConfederate forces at Cold Harbor, and thousands of his men were slaughtered.Don't underestimate your fellow investors or your competitors. You ignore themat your own risk. The crowd is smart.

There is an old saying that goes something like this: he (or she) who keeps his(or her) head while those around him (or her) are losing theirs, probablydoesn't fully understand the situation. This is usually the case. If a stock isfalling, the crowd knows something. Check it out. It's sort of like if you see acrowd of people running in the opposite direction you're headed—take note.There probably is a good reason for their flight, maybe wild elephantsstampeding.

In most investment markets the crowd is very smart, smarter than the mostintelligent people within the crowd. It is the crowd that determines the stockprice, and when stock prices drop dramatically for no reason, beware! Indymac,WorldCom, and Enron all signaled that they were headed off a cliff by theirprice action, even though these corporations denied having any criticalproblems. The FDIC didn't even have Indymac on its watch list of troubled banks.Nevertheless, you knew the bank was in trouble when its stock price droppedbelow $2 a share. Knowing the fundamentals was useless to the investor, but thetechnical action of the stock price revealed the truth. The stock price actionwill always tell you if a company is in trouble.

In horse racing, the crowd is so smart that it picks the winner of a race 33percent of the time and has done so for over 100 years. In the TV show WhoWants to Be a Millionaire, when members of the audience were asked aquestion, they were right over 90 percent of the time. Wisdom of theCrowd (Doubleday, 2004), a book written by James Surowiecki, will give youeven more evidence of crowd intelligence. One important point he made in thisbook was that a group's decisions are better than the decisions madeindividually by the smartest people in the group; groups can make quiteintelligent decisions.

Because the crowd is so smart and the crowd determines the stock price, it isdifficult to win in the investment game. All the available information isreflected in that stock price. Therefore, the only time you get an opportunityfor a bargain (and you should always be looking for bargains) is when the marketovershoots on the upside or downside. Determining when it will do that isdifficult, particularly when you're trying to predict the bottom of a market.You are supposed to buy stock when there is blood in the street, but in 2008there was blood in the street for a long time, yet stock prices kept falling.

Don't Underestimate Lady Luck

In addition to the efficient market and the smart crowd, another factor toconsider is Lady Luck. Many of the successful money managers of mutual funds aresuccessful, not based so much on skill as on luck. There are hot funds and coldfunds, but the hot fund today may not be a hot fund tomorrow.

The investment world is particularly affected by Lady Luck because of a termused in the science community—statistically significant.Statistically significant tells us if a specific drug treatment has anymeaningful effect on a patient. If the event is statistically significant, itwill, in general, improve the health or reduce the symptoms of a medicalcondition. If not, it tells you that the treatment is probably based on luck,which is random or has no significance. However, to be statisticallysignificant, you need a large number of events, and in the investment world,there are not a large number of events available to make a statisticallysignificant judgment.

An investor picks four stocks in a row that bring him profits. He thinks he isan incredible investor and deserves a place, if there was such a place, in theInvestors Hall of Fame. But four or even more successful stock picks in a roware not statistically significant and could be caused by the mischievous LadyLuck. Investors run hot and cold just like our water faucets. In other words,Lady Luck has a powerful influence in the cosmos, and the cosmos includes us,the investors. Don't allow Lady Luck to toy with you. She can be a ruthlesstrickster, deluding you, making you believe you are brilliant or dumb, andenticing you to calculate wrongly your odds of real investment success.

Lady Luck, the trickster, can make finding a winning investment system very hardto do. She can give you a winning streak when your system is actually a losingsystem, but you might not find that out until you're in trouble. And vice versa.You might have a losing streak when your system in the long run is a good one,but you might never find that out because you probably will have thrown the bookthat suggested it in the trash.

Testimonials and gurus are of no help in a cosmos influenced by the power ofLady Luck. Because we live in an uncertain world, the average investor has atendency to give too much credence to testimonials and put too much faith ingurus. Lady Luck affects all, including gurus, and one can't tell if theirclaims of success are based on luck or the real thing. Investment markets are abig gambling game, and Lady Luck is the house.

Beware the Soothsayer, Even If It's You

Trying to predict the future is not a way to beat the market. Many investorssubconsciously (or consciously) believe they can do this. But you cannot knowthe future until you are there, and no one, so far, has invented a time machine.We can dream like H. G. Wells, but we live in the present.

The soothsayer warning Caesar of his dastardly demise is either a myth or luck.(Maybe the soothsayer eavesdropped on the conspirators.) Whatever. Don't trustsoothsayers, particularly if they are money managers. No matter what tools theyuse, they cannot claim infallible knowledge of the future. As you have alreadybeen told, money managers don't have a good track record.

Despite knowing that we can't predict the future, everyone tries to beat themarket by doing exactly that. Unfortunately, 90 percent of all investors areterrible failures at trying to predict short-term moves in stocks, indexes, andfutures. Remember, year after year, 80 percent of stock mutual fundsunderperform the indexes and stock market averages. It is wiser to invest in anindex fund, where no management is involved, than in a mutual fund of stockswhere you have to pay management fees. If the professionals can't beat theaverages, how can the unprofessional investor do so? Future stock price actionsare unpredictable.

This, of course, doesn't stop the professionals from trying to find systems thatwill predict future stock and commodities prices. Brokerage firms spend millionsof dollars trying to find the system and have failed. Scientists, too, havetried to develop a system for predicting stock prices, also spending millions ofdollars, and they have not succeeded. However, check out The Predictors(Henry Holt, 1999) by Thomas Bass, which shows how a system to predict indexprices was developed by scientists after extensive research and testing.

And then there are the trend followers. Chaos theory does them in. Chaos theorysays that small unrelated events can have a major impact on future events ortrends. The unrelated small events are impossible to detect. Thus you can'tforesee their impact or plan for it. Having chaos theory attack and change thecourse of a trend can be mind-boggling, or at least disappointing, to the trendfollower.

Self-Reliance

Many investors are in search of a neat, wide path through the wilderness ofinvesting and are looking for a reliable guide to lead them. They have highexpectations for their guide, the Hawkeye of finance, a guru. They believe thatthis guide will lead them to the hidden gold or at least point them in the rightdirection. Here we're talking about investment analysts and their systems.However, as you know by now, there is a difficult truth. There are no systemsthat will work all the time, and although there are good analysts, they, too,will have their losing streaks.

What it comes down to is that being successful in the market depends on you. Theonly way to find a path to success in the markets is to forge ahead, relying onyourself to make a path and earn your success. Of course, you can use the wisdomof the experts, but make your own decisions and be willing to take theresponsibility for those decisions.

CHAPTER 3

Exchange-Traded Funds (ETFs)

The hottest phenomenon on Wall Street is the explosion of exchange-traded funds(ETFs), and they have made a revolutionary change in the investment environment.For whatever grouping can be imagined, a fund has been created. Like the canningof a huge variety of foods that are easily bought over the counter, ETFs packagean incredible variety of products that are easily bought on the stock marketexchanges. ETFs have also increased our financial mobility. The barriers aredown for investors. We can zoom around in the new expanding universe of ETFs atspeeds that were not possible before. The whole universe of investing isaffected. As the 1960s gave us the mutual fund boom and the 1990s gave us thehedge fund boom, the beginning of the twenty-first century has given us the ETFboom.

The Expanding Universe of ETFs

Not only do ETFs allow you to buy funds on every type of investment under thesun, but you can now buy a fund the way you would buy stock or metals, such asgold, silver, platinum, or copper. Also, you no longer have to understand how totrade futures to participate in that market. Even if you want to buy stocks inemerging markets, with ETFs you have numerous choices. In some cases, there areseveral ETFs that you can choose from in just one country. A short search on theWeb will reveal an unbelievable number of ETFs in the many emerging marketcountries. But let's start with the most basic investments—cash andcurrencies.

Minding the Money: Cash and Currency ETFs

Without traveling to countries that have desirable currency and stuffing yoursuitcase with it, how do you invest in cash or other currencies? Consider usingETFs. It's easy, and the choices are numerous.

To invest in the U.S. dollar, you can buy the UUP, the PowerShares DB US DollarIndex Bullish Fund. To buy other currencies, you again have ETFs to invest in.If you are interested in the euro, you can buy the FXE, the CurrencyShares EuroTrust. If you are interested in the Canadian dollar, you can buy the FXC, theCurrencyShares Canadian Dollar Trust. And if you are interested in the Japaneseyen, you can buy the FXY, the CurrencyShares Japanese Yen Trust. Another fundyou may be interested in is the FXA, the CurrencyShares Australian Dollar Trust,and the list goes on.

The beauty here is not only that all these funds can be purchased the way stocksare, but also that the funds closely follow the value of the currencies. Inaddition, with ETFs, there is no need to get involved in the futures market.Furthermore, ETFs allow you to invest a lot money in any currency.

Commodity ETFs

The new ETFs also allow you to get involved in purchasing commodities such asgrains, crude oil, gasoline, and natural gas. Again, you do not have to getinvolved in the futures markets, and you can invest a small amount if youdesire.

One example of grains is the DBA, the PowerShares DB Agriculture Fund. This fundtracks the performance of the Deutsche Bank Liquid Commodity Index. The DBAindex is composed of futures contracts on commodities such as corn, wheat,soybeans, and sugar. As indicated above, you can buy DBA just like a stock, andif you wish, you can buy just a few shares.

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Excerpted from UNDERSTANDING ETF OPTIONS by Kenneth R. Trester. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Edition details

• Publisher: McGraw Hill
• Publication date: 2011
• Language: English
• ISBN 10: 007176030X
• ISBN 13: 9780071760300
• Binding: Hardcover
• Number of pages: 240