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High returns with no risk, trading options? Sign me up …

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High returns with no risk, trading options? Sign me up …

… to test how much they spin the truth.

Over the past year, I’ve had a very aggressive investor ask me to help him find the “investing silver bullet,” that will make a lot of money with little risk. In fact, I’ve had many clients ask for this over the years – just none as headstrong as this one. He is convinced that there is a way to make a lot of money – likely trading options – without risk of losing principal. He was so convinced that early in the year, he gave me $500 to subscribe to a weekly options advisory that sends 2-3 daily emails with trade recommendations. The website boasted of 546% gains in a month.

I signed up for the service, and we set up a “paper-trading” account at OptionsXpress. I followed every email’s recommended buys and sells, and after 30 days, we were down 6%. However, on the website, the operator bragged of a 174% gain the last 30 days. He lied. Hi likely still lies on his website (I just checked and he says he’s banked a 2,062% gain since inception). There are many problems with his method of calculating returns, but the most egregious is the flat out lie about the performance in the 30 days I traded alongside him. I had to break the news to my client that this, unfortunately, wasn’t the investing silver bullet he was looking for.

A couple of months later, my still unconvinced client brought me another possible path to riches: an options training course that promised 95% winners. It only cost $99, so he gave me a one hundred dollar bill after I agreed to take the course. Keep in mind, when I tracked my Naked Alpha Fund options trades from 2007 – 2009, I had a 92% success rate on my options trades; so I wasn’t discounting this advertised 95% success rate.

After reading through the book (and before watching the video), I determined that this instructor was simply using historical statistics to push my 92% success rate to 95%. He also advised considering accepting a lesser 90% success rate, as the availability of potential trades and return increases. There is nothing wrong with his approach; in fact, I even incorporated his statistical analysis into my Naked Alpha Fund options trading to ensure at least 90% success. However, this 90-95% success rate comes with a trade-off: the returns are “boring”. With his “recommended hedged” strategy, we can expect about 0.25% per month after costs – or 3.0% per year – nothing to write home about. Of course if you leverage it three times, it becomes 9% per year, but the risk increases three-fold along with your return.

As much as I’d like to find that high return, low risk sure-thing investment, returns are normally commensurate with risk. There are very few opportunities that I’ve found over my 20 years of managing money where we can make a healthy return without taking on risk. One is the 90% certainty credit spread option trades that I execute in the Naked Alpha Fund. The other is my newest strategy, Closed-End Fund Arbitrage. In both, we hedge our exposure to the markets at a cost, but our success rate has been able to generate around 10% annually after-costs, with less than 50% of the volatility (risk) of the stock and bond markets.

Please keep bringing me ideas, and I’ll research and vet them in order to learn how to better invest for all of my clients. I’m not afraid to say I don’t know everything; but I’m also not gullible enough to think that paying anyone for investment advice will bring me great riches with no risk. You shouldn’t be either.