Are you effectively investing your money? Millennials are among the smartest investors, but not all of them follow this important process.
If you're a millennial, you may not remember a world without computers, and maybe not even a world without cell phones or the Internet. You might take it for granted, but you certainly have faster access to more information than any generation in the history of humankind. And, at the risk of oversimplifying, you’re also more aware of the larger world, and you like your own brains, researching everything you can to a fault—diet, fitness, work, finance, romance, and more. Wow. Considering your social creds, you could be the greatest investing generation ever. Or not.
Word has it millennials aren’t investing like other generations for one simple reason: trust. In your lifetime, you’ve processed the crash and listened to your parents disseminate Wall Street horror stories. You may not trust others to manage your money. And you want to be sure you can put your hands on your cash when you need it.
Lots of folks who came before you have orchestrated a secure retirement—and many haven’t. You’d prefer not to end up like the latter. So, you might skip the investing game altogether and take no chances. But you’ll also reap no potential reward.
The fear factor aside, you have one gigantic advantage over previous generations—awesome technology, like the thinkorswim® platform from TD Ameritrade. When you engage tech wisely, while learning the investing ropes, over time you’ll come to make informed decisions. And with much trial and error and trusting your own choices, you just might morph from cautious millennial to self-directed investor. Let’s deconstruct the fear arguments one by one.
The silver-screen version of Wall Street boils down to evildoers smoking cigars, bragging about huge kills, and fleecing the little guy out of hard-earned savings. But that’s Hollywood.
In real life, online brokers may boast a few cigar smokers in their ranks. But in general, they don’t trade your money, they don’t speculate against you, and your financial success is naturally in their best interest. In point of fact, many online brokerage firms invest tremendous resources in support and education, plus technology upgrades to protect a quality investing experience.
What can you expect? With most online brokers, nearly every aspect of your account remains transparent so you can monitor activity details, large and small, in real time. At the least, profit/loss is calculated for every trade and investment to gauge performance. It’s wise to log into your online brokerage account every day to review your account statement. There you’ll find your various transactions—order history, trade history, commissions, fees, deposits, and withdrawals.
Naturally, there’s no guarantee you won’t lose money trading. But how big that loss might be is something you can often manage. “Defined risk” is a term we use to describe an options trade whose maximum potential loss can actually be known before you route the trade. No matter what the stock price does, an options trade with defined risk can’t lose more than a precise amount. There are tools that can help you reduce the uncertainty of trading and calculate a trade’s maximum loss. One is the Order Entry Tools function in thinkorswim. Fire up the platform, then:
1. From the Trade page, create an order by clicking on the bid price (to create a sell order), the ask price (to create a buy order), or right-click to create a spread order, like a vertical (Figure 1).
FIGURE 1: GET COMFORTABLE PLACING ORDERS.
There are many different types of trades. It’s worth your while to experiment with things like vertical spreads, naked calls, or naked puts. Source: thinkorswim from TD Ameritrade. For illustrative purposes only.
2. This loads up the options and/or stock in the Order Entry Tools on the lower part of the Trade page. If you click the “Confirm and Send” button—don’t worry, you’re not sending the order yet—you’ll see details about the trade, including its max loss. (Only when you click on the “Send” button on the Order Confirmation Dialog box will you route it.)
As an experiment, create an order to short a naked call. The order confirmation box will show an “infinite” max loss. That’s because a stock doesn’t have an upper limit on how high its price might go. So, the loss on a short call has no upper limit, either. A naked short call, then, is not a defined-risk trade.
Next, create an order to short a naked put. The max loss might be fairly large because it’s the strike price of the put, minus the credit you get for selling it short. The max loss occurs if the stock price goes to zero. Although the max loss on a short naked put can be identified, it may be too large for you to be comfortable calling it a defined-risk strategy.
Finally, right-click an option and select “Sell,” then “Vertical.” That creates an order for a short vertical spread. Note that its max loss is the difference between the strike prices, minus the credit for shorting the vertical (Figure 2). When you look at the max loss on the Order Confirmation Dialog box, it’s not “infinite” like with a short call. And it might be much smaller than for a short put. Note that multi-leg strategies like this can entail substantial transaction costs (compared to single-leg strategies), including multiple commissions, which may impact any potential return.
Using the order entry tool, you can see how different verticals at different strike prices have different max losses. Some might be bigger than others, but they’re all defined. No matter whether the stock price goes infinitely high or to zero, a short vertical’s loss won’t exceed the max amount you see.
Above all, your risk tolerance is naturally your own decision. As a self-directed investor, you always control when, what, and how you trade. By controlling the max loss using defined-risk trades, you can be confident that even if all your trades are losers, your account might still have some value. For example, if your account is worth $5,000, and you have three defined-risk trades each with a max loss of $250, the worst-case scenario is each of them losing $250 for a total loss of $750, plus commissions. So your account would still be worth roughly $4,250.
FIGURE 2: KNOW YOUR MAX LOSS BEFORE YOU TRADE.
In the Order Confirmation Dialog box, you can determine what your trade’s max loss and max profit is likely to be. Source: thinkorswim from TD Ameritrade. For illustrative purposes only.
OK, maybe it’s not exactly fear. But it stinks when you see people around you making money when you’re not in the game, especially in bull markets. You know the threat of loss is real, despite your expectation that the market could move even higher. You’re afraid of making a mistake, or getting in too late.
Of course, telling someone to “have no fear” is easier said than done. But it doesn’t have to be all or nothing. You might convert your fear into thoughtful, informed trading strategies that don’t break your bank in one day. Is risking, say, $300 on a single trade acceptable if it means you slow things down a bit, participate in the growth of the market, and focus on strengthening your portfolio for the future? (Yes, trader—we do mean investing for the long term, here. But it’s not what you think.) Let’s take an example.
Assume you’re bullish on the market and you think it’s going to move even higher. The “market” can mean a lot of things. But to many investors and traders, a good proxy is the S&P 500 Index (SPX). It tracks the value of the S&P 500, and it carries options. What does a defined-risk, bullish strategy on the S&P 500 look like?
Maybe a short put vertical in SPX options. This would be short an out-of-the-money (OTM) put, and long a further OTM put. With the SPX at, say, $2,410, a short put vertical could be short the SPX 2390 put, and long the SPX 2385 put. If that 2390/2385 put vertical is worth $2, selling that put vertical generates a $200 credit. That’s your max potential profit (not including commissions), which you’d realize if the SPX price is anywhere above $2,390 at the options’ expiration.
The max potential loss on that short 2390/2385 put vertical is $300, and that loss would happen if the SPX price is anywhere at, or below, $2,385 at the options’ expiration. Even if the market crashes badly and the SPX goes to zero, the most this trade will lose is $300, not including commissions.
Only you can decide whether you think the SPX will go higher. There are lots of other bullish strategies to choose from. But this example of a short put vertical should put at least some of your fears in context.
Of course, no one wants to lose money, and options trading involves unique risks and isn’t appropriate for everyone. But if you’re looking to invest in your future and potentially realize better returns than from a savings account, you may have to engage some risk. Above all, the wealth of trading technology today means you’re never alone. Once you get more comfortable with investment decisions and risk/reward equations, you’ll likely trust yourself more, so that trading your own money starts to feel familiar and often worth it.
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Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Spreads, Straddles, and other multiple-leg option strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return. These are advanced option strategies and often involve greater risk, and more complex risk, than basic options trades.The naked put strategy includes a high risk of purchasing the corresponding stock at the strike price when the market price of the stock will likely be lower. Naked option strategies involve the highest amount of risk and are only appropriate for traders with the highest risk tolerance.
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