What Not to Do as a Beginning Options Investor

Investing using options is very different from constructing a classic long-term buy-and-hold portfolio.

In this segment from Motley Fool Live that first aired June 7, Motley Fool Canada analyst Jim Gillies and Fool.com editor/analyst Ellen Bowman discuss some of the choices beginning options investors should avoid.

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Jim Gillies: I’ve also made every mistake possible, trust me. No, Ellen, I’ll tell you, my early, and we’re going back, it’s almost 20 years ago now. I had the brilliant idea, this is brilliant. It’s so brilliant if you could see the train coming.

Ellen Bowman: I’m going to close my eyes. Go ahead.

Gillies: The brilliant idea I had was sell puts on small biotech companies.

Bowman: Okay.

Gillies: Small biotech companies with one or two drugs in the pipeline that could either change life as we know it, or end up being a compound that has the efficacy of water, but you don’t know yet.

Bowman: The clinical stage, no revenue yet.

Gillies: Exactly. If this thing wins, yay, and it’s tea and medals all around, and if it comes up with bad results, it’s going to be bad day for the stock. I said, “Okay, well, this is brilliant. I’m going to do this.” But I’m only going to pick small biotech companies where their results are expected to be released in a month or two at the earliest.

Bowman: So you’re going to go super short term on it.

Gillies: I’m going to go super short. I’m going to do one or two weeks and that’s going to be free money, and I’m going to bring it in. It worked great, it worked great for about six months. Then I wrote puts on it, I don’t even remember the name of this one, it’s probably gone by now, anyway, it doesn’t matter. But I wrote puts on this thing that was not supposed to release results for about two months, and I think I wrote some puts. I think they were expiring that Friday, and I think I wrote some puts on the Monday and I think I wrote some puts on the Tuesday, and on the Wednesday morning before the market opened up, they pre-announced the results of their trial. Fun fact, if a biotech company with running tests pre-announces results, they’re not good.

Bowman: Yeah. They’re not excited to tell you about this.

Gillies: Yeah. So I had 25 dollar puts written. I had the stock opened up at eight. Basically, this is called how Jim loses 5,000 dollars before breakfast.

Bowman: [laughs] On Wednesday morning. One Wednesday morning.

Gillies: One Wednesday morning, yeah.

Bowman: They had been going so well until then.

Gillies: I wiped out six months of trading profits before breakfast. It was all gone.

Bowman: So what’s our takeaway for people watching here? Don’t write puts on clinical stage biotech companies right before earnings?

Gillies: Or any time at all.

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