Are you an investor or a trader? This is a question some of us don’t ask ourselves, but the answers define how and when you get in or out of positions. The dilemma for many would-be investors is that end up trading when they intend to invest for the long term. Using options to manage your portfolio solves some of these problems.
Ask yourself these questions to decide where you fit:
1. Do you sell long stock positions in order to take profits? So many people buy stock intending to hold for the long-term, reinvesting dividends and relying on exceptional management to see them through the dips in price -- only to impulsively sell to take profits when they appear. This could mean you’re more suited to trading than to investing; but what do you do when your stock loses? Do you close to cut your losses just as you close to take your gains?
2. When your stock positions lose value, do you hold on indefinitely, requiring a rebound just to get back to even? If you hold on to losing stocks but sell the winners, you are going to end up with a portfolio of under-performing stocks. If you sell to take profits, you also need to sell to take losses under the same assumptions. It makes sense to match up gains and losses to offset gains and reduce income taxes.
3. Do you end up holding stock for only a matter of weeks instead of months or years? You might intend to be one of those buy-and-hold folks, but end up moving positions around quite frequently. This could mean you want to be a trader and not a value investor. Some self-evaluation is worthwhile to make this determination.
4. Is your trading style different than you intend it to be? If you are compelled to check your positions every day, and if you worry any time price tick downward, you might not be an investor. Traders tend to take advantage of those short-term wave movements in price, but a true investor picks stocks carefully and then lets them ride.
Some people are suited to investing but do not want to suffer the short-term fluctuations in stock prices, especially when markets are volatile as they are now. One solution worth looking at is using options not to speculate, but as a portfolio management tool. You can sell covered calls after fast price run-ups or buy puts, either one as a method for taking profits without needing to sell stock. On price dips, buying calls (or even the more speculative naked put sale) achieve a similar advantage.
Options allow anyone, even the most conservative buy-and-hold investor, to swing trade those troubling short-term up-and-down prices, earn some extra profits, and still hold shares of stock for the long term.
Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to several blogs: CBOE, Seeking Alpha and the Global Risk Community.