A lot of new investors are playing a dangerous game. They’re speculating in options–betting that stocks will keep going up.
So far, they’ve been lucky. But comes the fall, many innocents are going to face what Wall Streeter Ray DeVoe calls The Crack of Doom. That’s the day when you know not only that you are going to lose money but that you are going to lose a lot more than you can afford.
Some speculators appear to be taking lessons from Wade B. Cook, a former cabdriver whose “Wall Street Money Machine” is a bestseller among business books. It tells how to get rich quick playing stock options.
At nearly 400 seminars this year, Cook wannabes will pay as much as $4,695 a pop to learn the master’s secrets–among them, his formula for producing what he calls “sane, safe, and comfortable 20 percent to 40 percent monthly returns.”
Sane? Cook tells me his definition of sane may differ from mine, because mine is boring.
One thing probably not taught at the seminars is his interesting history over the last 10 years: a current, informal investigation by the Securities and Exchange Commission (he says there’s nothing to it); a Chapter 7 bankruptcy (discharged); and cease-and-desist orders in several states for selling unregistered securities (he says he didn’t do it). Arizona hit Cook with a $150,000 penalty for misrepresentation and fraud (not yet paid), plus an order to repay nearly $391,000 to investors (Cook says he’ll pay double).
Why are options so appealing? If the market moves in your direction–a big if–you can ring up a large percentage gain on a small investment.
Say you buy a call option on a stock. You’re betting that the price will rise by a certain amount over a fixed period of time–a few weeks, a few months, or even three years.
When stocks split, they commonly divide in half. One $80 share becomes two $40 shares. There’s zero change in the company’s value. Even so, the stock often rises–maybe because it attracts more buyers; maybe because stocks split when companies expect profits to improve.
But only in this helium market would grass-roots investors assume that the price will always move high enough, fast enough, to cover the cost of the option plus sales commissions. If they don’t, you risk losing every penny you put up.
Seattle financial planner Mark Spangler of MFS Associates says he just talked a client–a divorced woman earning $60,000–out of playing the stock-split game. The client told Spangler, “It looks like it’s guaranteed. You can’t lose money on this.” That’s a dangerous phrase he’s hearing more and more.
Only one person is guaranteed not to lose money: your stockbroker. For a small option trade–a buy and a sell–you might pay 6 percent or so. If you do that every couple of months, you’ll need to make a lot of money just to cover your costs.
A conservative use of options being touted is to buy a put on Standard & Poor’s 100-stock index. If stocks fall, the put makes money, which offsets part of your market loss. If they rise, the put expires worthless.
Buying puts is praised as a way of protecting shares you’ll soon want to liquidate–say, to raise cash to buy a house. But that kind of money shouldn’t be kept in stocks at all. (Never sell a put. You risk losing far more than you put up.)
Financial planner Mark Sievers of Sievers Financial Consultants in Fairfield, Calif., studied options in graduate school and wouldn’t dream of suggesting them to most clients. Not so Wade Cook. His Web site brags that he’ll teach you to double your money in “2 1/2 to 4 months.”
Don’t count on it.
