Saturday, January 7, 2012

Chapter 3: What are your Future Options?

A British schoolboy cricketer had once approached Sir Geoff Boycott to learn how to play the hook shot. Boycott told him that the best way to play the hook shot was not to play it!

"But how do I score runs?", the boy had asked. Boycott's response was typical: "Don't get out! The runs will come.”

Futures and Options (F&O) trading by small investors are akin to a young cricketer playing the hook shot. The chances of losing money overshadow the probability of scoring big. It is far better and safer to buy quality stocks and wait for your wealth to grow.

Nowadays the lot sizes for F&O trading have been reduced, but the risks have not. Such trading is better left to professional and institutional investors who play for much bigger stakes and usually buy or sell in the cash market and hedge in the F&O market.

There is no harm in being aware of what F&O trading is all about, and some smart investors can get clues about the market levels from the open interest volumes and the difference between spot and future prices. But I get confused when I hear talk about 'covered calls', 'strangles' and 'naked futures' and have stayed far away from F&O trading.

Seems like I'm not in a minority of one. The legendary Peter Lynch has made the following comments in his book ‘One Up on Wall Street’:

"I've never bought a future nor an option in my entire investing career.... Reports out of Chicago and New York, the twin capitals of futures and options, suggest that between 80 and 95% of the amateur players lose. Those odds are worse than the worst odds at the casino or at the race-track, and yet the fiction persists that these are 'sensible investment alternatives'.... I know that the large potential return is attractive to small investors who are dissatisfied with getting rich slow. Instead they opt for getting poor quick.... Warren Buffet thinks that stock futures and options ought to be outlawed, and I agree with him.”

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