By: Dividend Sensei
I’ve been investing since the age of 9 and over that 22 year (almost 23 now) period I’ve learned what works, but more importantly what doesn’t. This includes many wasted years dabbling in every get rich quick scheme under the sun including:
- Day trading
- Momentum/technical analysis trading
- Options speculation
- Short selling
- Currency trading
- Leveraged investing
I’ve now earned several PhDs from the school of hard knocks (most expensive tuition in the world) by making and then losing several fortunes. Which is why I’ve now devoted my life (and career) to preaching the gospel of long-term, buy and hold investing in quality dividend growth stocks. Numerous market studies (and personal experience) have shown that this is the single best approach most people can take to getting (and staying) rich over time and achieving their financial goals. So let’s take a look at the three of the most dangerous investing strategies available to investors today, to see why they will almost certainly cost you a fortune and should be avoided like the plague.
Naked Option Speculation
The single biggest mistake I ever made was speculating in Apple options when in medical school I stumbled upon what I thought was a sure fire way to earn a vast and quick fortune. This strategy involved using out of the money naked call options. Essentially these are speculative contracts that give you the right to buy shares of a stock by a certain date at a certain price.
While there are low risk option strategies used by institutions such as insurance companies and pension funds to generate income (covered calls and cash secured puts) naked options are pure speculation and highly leveraged ones at that. In essence the strategy that I used was a form of super leveraged (up to 50 to one) short-term stock price timing. At the time Apple hadn’t missed on earnings for 28 straight quarters (7 years of beating expectations). The stock had followed a predictable pattern of spiking after an earnings beat (average of 7%) then selling off about 10%. It would then gradually rise ahead of earnings and the next spike after the company yet again beat its low ball estimates. The idea was simple. Having crunched the data and knowing how much the stock usually went up and down through these cycles I would wait until the stock had likely bottomed around the middle of its cycle. Then I would buy lots of out of the money call options that were calculated to earn 100% to 200% returns when cashing in after the next earnings beat and price spike.
In theory I was hoping to double or triple my money each quarter. That would have meant wealth compounding on a massive scale and could have made me a millionaire by the time I graduated from Army medical school. The system worked wonderfully for two cycles. I managed to achieve 130% and 150% returns and turn a mere $20K into $115K in just six months. But the third time? Going into earnings I was up big, $175K for that cycle. My father begged me to take the money and run. However I got greedy and with Apple expected to pop 5% to 9% post earnings I was potentially looking at another $100K to $150K in profit. Well that was the first time in over 7 years when Apple finally missed expectations.
Apple stock plunged 13% the next day and I suddenly saw $290,000 turn into $13,000 in a single day thanks to the super high leveraged nature of naked call options. And because of the time sensitive nature of these things I was forced to soon cash out with just $23,000. I lost 92% of my life savings because I was stupid, reckless and forgot that option speculation requires you to be right not once, not twice, but thrice. You need to be right on the direction of the share price move, the timing, and the magnitude. Being wrong on even one of these things means that the options expire worthless and you lose everything.