Buying OTM puts on Citi (C)

Show of hands: how many of you have been tempted to load up on purchasing cheap, out-of-the-money options as a speculative play? It's a common move and often a dangerous one. Case-in-point is this recent forum discussion around buying puts in Citigroup (C). TK client ShadyRady writes:

SR,

In addition to the many useful comments you've already received on this thread, I have a few thoughts. Your innocent-looking request - to hear thoughts on your trade - brings up two serious problems that rookie traders must understand.

The obvious comment is that it’s a bad idea to be "heavily invested" in any one position. Most money management techniques begin with accepting trades only when the maximum loss is not devastating. In fact, to become a successful trader, I believe that losses should be limited to an amount that can be shrugged off as the cost of doing business.  

Buying out-of-the-money (OTM) options is pure speculation, and investors who do buy them must be prepared to lose their entire investment most of the time. If you are not so prepared, then you purchased too many contracts. 

I blogged about this recently in a blog entitled The Siren Song of Cheap OTM Calls. The underlying in question for that post was also Citi, but the principle applies to all cheap options you may be tempted to purchase. Brian Overby, the Options Guy, has also blogged on this subject - check my previous post for links to read his commentary.

As to your Citi puts play specifically, who knows? This bank, as well as others, would clearly be insolvent if forced to mark their paper to the market. Apparently they will never be forced to take that step and it’s anyone’s guess whether the stock will rally or stumble. Time is short.

Regards,

 

Mark Wolfinger
Partner, ExpiringMonthly.com and Founder, MDWOptions.com
TradeKing All-Star Commentator

Mark Wolfinger holds no positions in the securities mentioned above.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs. 

Mark Wolfinger maintains a business relationship with TradeKing.

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