I found something on the Zecco.com - Free Stock Trading & Investment Community website. Here's the link to the conversation and my response to it: Asset Allocation - Zecco.com
Uncle Billy:One suggestion for you is to get the various synthetic option equivalencies in your head so that you can see what positions are the same and why. In my experience retail option traders are often clueless as to what they really have on.
As a stock broker, that seems like a very scary thought that people enter into call option contracts without really knowing what they're doing. It's one call option contract for every 100 shares shorted or one put option contract for every 100 shares held long. Any more would be over-hedging and any less would be under-hedging. I don't put much stock in beta values as these are only based past estimates to attempt to make future predictions.
I think that everyone who's considering on investing in options should read the disclosure document. Also, you need to really understand options before investing in them. The most important things to learn in options is about probability, risks, and proper hedging.
These, at a minimum are questions you need to ask yourself before you invest in options: Should you write options or buy options? Do you need the income stream from options with stable stocks or are you looking to speculate in stocks? Are you looking to hedge or make lots of money in options? What's the cash burn of each option; in other words, how efficient are options as a use of speculating in price increases or decreases and how many options contracts will it take before you have lost your entire investment capital? Do you have more than 5-10% of your money speculating in options? What's your maximum profit and loss that you could face? Is it unlimited? If you speculate in options, are you going to use covered or uncovered options? With put-writing, are you going to have cash-secured puts or rely on margin? If you rely on margin, what investments are you going to use the proceeds for? Are you going to attempt to manage risks with this money? If you have a cash-secured put, what are your investment limitations? Is it a deposit, can you invest it in Treasuries, a balanced fund, etc? In a short straddle, are you going to own the underlying stock or in a long straddle, are you going to sell the stock short or hold long? Would you consider having a put or call spread instead of owning the underlying stock? Will options in the long run provide you with an equivalent risk-adjusted return as to owning individual stocks or ETFs?
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