Using Options in Retirement Investing
Stock or Commodity Options Can Supercharge Retirement Income
Sep 30, 2009
Trading stock or commodities options is considered too risky for retirement portfolios. By avoiding risk throughout retirement investments, returns on the portfolio are also limited. Options can bring limited risk and high returns to an otherwise average performing retirement portfolio.
Fear of Options Investing
Among major mutual fund companies such as T. Rowe Price, Fidelity, and Vanguard their recommendations will vary widely for how much money the average person should invest in stocks, bonds, and cash for their retirement. One thing they all agree on – is not trading options. Options are considered too risky and not significant for the performance of the overall portfolio.
One of the greatest stock and commodity traders in history, Paul Tudor Jones, interviewed by Joel Ramin in 2000 set his risk tolerance as "If a trader can on average annually deliver two to three times their worst draw down, then that's a very good track record, and I'd say that that's what I try to do. If I thought that for the funds that I managed that 10% would be the worst that I would tolerate in a given year then hopefully I'd annualize two or three times that and that's probably what I've done." An example: A retirement portfolio of $250,000 contains 40% bonds, 40% stock, and 20% cash. There is $50,000 in cash (20% of $250k) that offers an astute options investor the opportunity for earning large profits. Following the loss limit rule, the loss limit is $2500.
With the $2500 limit in mind, a $5000 limit for an options purchase will allow a large cushion for avoiding breaking the loss limit rule. Setting a stop loss order if the option price moves against the position by 50% provides the escape route.
High Returns, Limited Risk in Trading Options
Investing $5000 in trading options can realistically provide a 25% return within weeks so long as a proper options strategy, such as this trend turn trading system is used. Positive returns are not guaranteed by any trading system, only the odds can be put in the investors favor. More often, the returns can be much larger – 50% or more. Taking the conservative number of 25%, that yields $1250 in profit. Assume the profit is net of all trading costs for options. Trading costs are significant – often well over $150 for a $3000 options trade, depending on the number of options and the broker used. $1250 annualized is $15,000 or over 5% of the portfolio!
Risk has been limited to less than 1% of the portfolio while a possibly providing over 5% return while the bonds will only provide 4% or less on average currently. Meanwhile, bonds are not risk free because of the huge interest rate swings that could be directly ahead. Stocks have provided a wild ride from the S&P500 around hovering 1500 in 2000, to its’ current level of 1060 in 2009.
Stocks are far riskier based on how much of the portfolio they occupy, how the downside is harder to limit. The potential upside is often much lower in the large capitalization stocks than in trading the options. Adding options to a retirement portfolio works only if the person trading options understands how to pick the turning points in the market and limits risk. With sufficient knowledge of options trading strategy, options can supercharge a retirement portfolios returns, and supercharge a retirement!
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