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I've encountered a group of questions and comments from traders that tells me that traders have a certain way of viewing the world.  These each represent part of the Trader's Mindset.  Today I'll tackle one of those questions: How much can I expect to earn when using options?

Bernie Schaeffer, from Schaeffer's Investment Research, long-time options analyst and trader offers his comments on why an investor should be trading options in today's market. After reading the piece (quoted below), I tried to communicate with him via his website. I wrote that I was going to offer contrary opinions and asked if he wanted to discuss the issues.  I received no response.

Here’s one of the most perplexing risk evaluations I ever heard (read) from a seller of naked options: "I was never in any danger. The stock was always higher than the strike price of the puts I am short." This person was convinced that the only time risk must be considered occurs when short options move into the money.

Recently there has been much discussion in the media about the new "fiduciary rule" Obama imposed through SEC regulations.  Despite the industry outcry, this actually is a great thing for consumers and could go to end many of the practices that I find deplorable which are common in the investment advisory industry.

There is a subset of option traders who seldom, if ever, are willing to pay cash.  All  initial trades, all adjustments, all rolls – must be made at a net cost of zero or less.  The only exception occurs when exiting a trade and collecting a profit. Can it always work? 

I often refer to selecting a proper position size as the easiest and most important risk-management technique for the individual trader. It is always tempting to trade bigger size, especially when confident. Big size can produce big profits. Traders believe that earning bigger profits is the path to wealth.

The Sharpe Ratio is a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such calculations. It was developed by Nobel laureate William F. Sharpe. The Sharpe Ratio is the annualized return of an investment earned in excess of the risk free rate divided by the investment's annualized volatility.

Whenever we talk about stock market trading discipline, everyone seems to understand that we are referring to trade decisions. We know that good discipline is required to pull the trigger and exit a trade with a loss. It really should not be difficult. After all, we know our position has not been working and is not likely to get better any time soon.

For most option traders their first encounter with options was probably Covered Calls. Covered Calls are easy to understand, seem to have very little risk and convey the feeling of being more than just a “plain investor”. They are still the most popular option strategy.

It is one thing for a trader to state that he anticipates that the markets will become more volatile and it’s another to create a plan to earn money when that volatility prediction turns out to be correct. For example, the immediate question becomes: What is the source of the profits?

Question from a reader: What about trading the weeklies (naked puts and calls)? The time span is very short and if you are more conservative, you can skip the weekends and start on Monday and bet on about 4 days. You can still get about 10% return per week with very little risk.

There is more than one way to look at every situation. My individual perception may be different from yours. Part of the time there may be room for interpretation because the ‘facts’ are soft and may be considered from different points of view. At other times, the facts are undisputed, but people have different interpretations. Here is one example.