Grigory Lukin Let's Retire Young www.letsretireyoung.com options doors choices calls and puts

On Calls and Puts (with a Special Guest – GameStop!)

Calls and puts may sound enticing, but it’s best to steer clear.

Investing can be a fascinating pastime, as well as a very rewarding hobby – both figuratively and literally. Earlier, I wrote about the more traditional types of investing – stocks, covered calls, and even investing in yourself. There’s another topic that I’d like to talk about: calls and puts.

Before I proceed, a public service announcement: I’m not a financial advisor, I’m definitely not your financial advisor, and all of this is purely for entertainment purposes. (Don’t sue me, bro!) Also, make sure to hydrate, get enough sleep, and don’t play with matches.

Now that all the life advice/disclaimers are out of the way, let’s dive in. What are calls and puts? The very short answer is that they’re remarkably dangerous gambling instruments that are best left alone. A slightly longer answer is this: a call is a contract that gives you the option to buy a certain security at a certain price in a certain timeframe; a put is a contract that gives you the option to sell a certain security at a certain price in a certain timeframe. For a much longer answer, head on over to Investopedia and check out the articles on calls and puts.

Grigory Lukin Let's Retire Young www.letsretireyoung.com options doors choices calls and puts
One of these doors might make you money. One might bankrupt you. (Image by Arek Socha from Pixabay

A brief side note: Investopedia, much like Wikipedia and most other -pedia’s out there, is an amazing resource. It is my heartfelt belief that anyone can learn almost anything (they’re still keeping nuclear bomb blueprints secret, but aside from that…) if one were just to sit down, turn off all the distractions, and simply stare at the screen until all that knowledge clicked. A lot of it is quite technical and often rather boring, but all that information is out there – and it’s free.

So, in a nutshell: if you think a stock (or, say, an entire index, like SPY – S&P-500) will go up, you can buy a call, and then either resell it to somebody else for profit, or hold (or HODL) it long enough to exercise it. It’s the same principle but opposite execution with puts: if you think a stock (such as CHWY – Chewy – which hit its 52-week-low earlier today) will go down in price, you can buy puts, and either flip them or exercise them as you see fit.

It’s important to note that most options expire worthless: just like in every gold rush, the people who make the most money are the storekeepers who sell all those picks and carts and shovels. With options, it’s the options sellers who usually make the most cash. It’s entirely possible to make a perfect contrarian bet, to anticipate some stock’s movement, and make 10,000% or more in a matter of days. That really does happen, but it’s about as likely as winning the lottery: somebody always wins, but everybody else loses. (Or, if they’re lucky, they might break even.) 

That’s the fundamental difference between investing in stuff (Beanie Babies, or stocks, or even crypto) vs investing in calls and puts and other, more exotic options. When you’re wrong with your bets on calls or puts, and when they expire worthless, you lose all that money. (If you move fast, you might be able to recoup some of it by selling it at a loss to somebody else: see the Greater Fool Theory.) With other investments, you might suffer a loss, but you’ll still have that investment until you choose to sell it. (Or the company goes broke – either/or.) Some of those turnaround stories take a long time, but they’re possible if you’re sufficiently patient and believe in your original thesis. (And hey, those Beanie Babies are cute.)

Do you remember how Bruce Wayne went bankrupt in Christian Bale’s final Batman movie, “The Dark Knight Rises”? After Catwoman stole Wayne’s fingerprints, Bane used them to buy a lot of puts that expired worthless in this overly dramatic scene. Two lessons here: first, enable two-factor authorization on your trading accounts; secondly, puts (and calls!) can bankrupt anyone if they go all in. (It typically happens in far less dramatic fashion, though.)

From my personal experience, I had mixed luck with options: I made 350% on some BB (BlackBerry) calls in 2021 because I thought (and still think) the company is quite undervalued. I bought them when the stock was low, then sold them at the very height of June, when the stock price shot up from $9 to $20.17. Good times… On the other hand, I also lost a fair bit of money by buying calls and puts both short- and long-term) on what seemed like sure bets. That’s why one of my investing resolutions for 2022 is to stop buying options, and to only sell covered calls, as well as cash-secured puts (aka CSPs), which do the same thing in reverse. (Here is a relevant and useful article on this topic.) 

The only exception I’m making in 2022 is this: I strongly suspect there will be a correction caused by either covid-related slowdowns or regular people liquidating their stocks (and stonks, and cryptos, but hopefully not Beanie Babies) to pay their taxes on all the realized gains from 2021. I’ve set aside enough money for my taxes, but I think most people didn’t… That was one of the contributing causes for the dot-com bubble crash, which happened in March 2001, right when folks started selling their stocks to pay the tax man for their 2000 gains. (There were, of course, other factors.)

SPY hit its all-time high of 479.98 earlier this week. Let’s say I’m a pessimist and think it’ll fall at least 6.25% this year, but I don’t know when. I bought 450p puts for December 2022, which means I have the right to sell SPY at $450 if it falls below that level. I.e., if it crashes all the way to 300, I can sell it for 50% profit. It almost certainly won’t come to that, but if there’s a significant correction, I’ll be able to resell my puts for a nice profit. Of course, if I’m wrong, I lose everything, which is why this investment is only a small fraction of my portfolio. Those puts were $27.90 (or $2,790 per contract) when I bought them three days ago. Earlier today, they were trading for $31.41, or 12.6% gain in just three days, thanks to S&P-500 falling right after I bought the puts. (Lady Luck smiled upon me.)

Theta decay is also an issue: the closer you get to the expiration date on your calls and puts, the less valuable they will be. (That means my 450p SPY puts will rapidly fall in value as we get closer to December, even if the SPY’s price remains the same.) Some people invert that by trading 0DTE (zero days till expiration) options. For example, if a stock (or an index like SPY) falls in price at the beginning of the day, you can buy calls and hope/pray/manifest that the price will go up by the end of that day. If it does, you can make a lot of money (well over 100%) on your options. If it doesn’t, you lose it all. Ho hum.

Let’s look at a real-life example: the stock that everybody loves to hate, the unpredictable and volatile David to Wall Street’s Goliath – the one, the only GameStop! (Aka GME.) It’s incredibly volatile, which makes it a good stock to study for market movements. (Some stocks, like Coca-Cola, are remarkably stable by comparison: think sleepy turtles vs cocaine-fueled bunnies.) This particular week – the first trading week of 2022 – has been particularly volatile. Let’s take a look:

Grigory Lukin Let's Retire Young www.letsretireyoung.com GME GameStop stonk diamond hands apes stronk together calls and puts
GameStop’s 5-day trading chart between January 3-7, 2022. Volatile, isn’t it? (Image source: Yahoo Finance.)

If that sounds absolutely wild and bizarre, congratulations – this is a perfectly rational reaction. After all, it flew from $121.14 to $172 in just a few hours: a 42% gain if you timed it perfectly. If you’d had all that information a week ago, you would’ve been able to make an easy million dollars by selling calls and puts. For example, when it opened at $159 on Monday, you could’ve bought 120p puts (120p is the cool technical term for $120-strike puts) and sold them for a humongous gain on Thursday as the stock crashed to $121.14. Then you could use your omniscience to buy 160c calls on sale (all these calls and puts would have Friday as their expiration date) and resell them at a huge profit when the stock jumped from the Thursday closing price of $131.03 to the Friday opening price of $159.77. (There is no options-trading during the afterhours trading, sorry.) And, finally, you could have completed your victorious trifecta by taking all your gains and quickly buying 135p puts, which would’ve greatly appreciated in price as the stock fell to the Friday low of $132.50.

This is a purely hypothetical scenario, and you probably would’ve ended up getting kidnapped by the CIA’s unit in charge of tracking down psychics and/or time travelers, but still – it’s hypothetically possible that, if you played everything just right, you would’ve made millions in one week. Do you see how complicated and unpredictable all of that is, though? And can you guess how many people lost it all by going into the full-on FOMO (Fear Of Missing Out) mode? I keep 100 shares of GME for sentimental (and swing-trading, and covered-call writing) reasons, and I ended up making a few hundred dollars and then slowly backing away as I sold my shares. (Definitely not at the top. Heh.) I fancy myself an experienced investor, and that was too much even for me.

So, in conclusion: don’t go chasing calls and puts waterfalls, please stick to the investing rivers and the lakes that you’re used to. Calls and puts can be exciting and sexy and dangerous, but they’re also a very fast way to lose it all. I said this before, and I’ll say it again: most folks are better off with index funds. They’re the exact opposite of exciting and sexy and dangerous (unless you’re really into the concept of compound interest – I don’t kink-shame), but they’ll eventually get you where you’re going. And as a bonus, you’ll get a lot less stress along the way, eh.

Stay safe out there, dear reader. And if you have your own thoughts on calls and puts, feel free to share them below!

Leave a Reply

Your email address will not be published.