02 Feb If the Risk is Worth Taking, Do it and Manage the Risk
Thank you for all the encouragements and well wishes after I made a big loss in trading.
While most people understand why I lost money and the message of the article, there is a handful of readers who thought that I lost money because selling naked options is risky.
I would like to write this article to reiterate my message as it is important readers get it.
Is Air Travel Risky?
Ever since air travel was made possible, people had the fear about airplanes falling off the skies. Even though some of us still hold that perception that air travel is risky, statistics have shown that AIR TRAVEL IS NOW SAFER THAN DRIVING A CAR:
- Americans are far more likely to die driving a car than they are riding in an airplane.
- Flying is 22 times more safer than driving car
- 2012 was the safest year for US aviation since jet planes were used.
If the risk is worth taking, do it but manage the risk
When something is risky, it does not mean we do not do it. In fact, knowingly or unknowingly, we take risks everyday. There is risk crossing a road. There is risk taking a bus. There is risk eating in a restaurant. There is risk when we exercise. It is impossible not to take any risk in a day.
The more important question is, “Is the Risk worth taking?”
The answer is yes to air travel because it will take a long time to travel by road or sea to visit a faraway country. Air travel has improved business efficiency and brought many people to see different parts of the world.
The second question is, “If the Risk is worth taking, how do we manage it?”
The airline answered that question and brought accidents under control. Risks associated with a dangerous endeavour can be managed to a safe level.
Starting business is risky too. But it is definitely worth doing, at least at the societal level. If everybody has an employee mindset because we all want to avoid risks, who is going to employ us?
Hence, taking and managing risks are part and parcel of businesses and capitalism.
There was a scene from the movie, Margin Call. The CEO called the principals for an emergency meeting because the company may go bankrupt with all the excessive risks it was taking. The CEO educated a junior analyst why he gets paid more by sitting around in meetings to make decisions – the CEO’s sole role was to keep the company alive to make money. In pure sense, risk taking and management.
Is Stock Picking worth the Risk?
Stock picking is hard. Most funds cannot beat the index. Most retail investors cannot even get positive returns. Why are we still trying to do it? Why not just invest in index funds?
This is because stock picking is worth it. When we get it right, it gives us an extra few percentages more than an index fund returns, and this can mean millions of dollars over a long period of time, depending on the capital and investment time-frame.
Is Selling Options worth the Risk?
Yes (to me), because I can potentially make 3% return on capital per month, or 42% per year. However, it is not possible to make money every month because the market may over-react to certain events and an option trader can suffer losses that eat into the profits. The trader’s role is to protect the capital as much as possible during these events, and probably achieving 20% per year seems more reasonable.
Let me reiterate my message – all forms of trading are risky. You are learning the wrong lesson if you think that trading other stuffs (stocks, forex, futures, CFDs) are safer than options. My mistakes were over-leveraging and not cutting loss. Applying both these mistakes to other trading products will result in blow ups too! It is not just the product, it is how the trader approach and manage the risks that matters more.
A trader who trades forex who doesn’t cut loss isn’t ‘safer’ than a trader selling options who cuts losses.