Fear and Greed: an Interlude

At the root of my last post but never explicitly stated were those darned emotions of fear and greed.

Talking about drawdown (DD) analysis took me back to the idea that options are better than stock. DDs trigger the fear inherent within. This threatens catastrophic loss when I have to close positions at the worst time to maintain sanity. I have argued that long stock can always lose more than the naked put (NP) and is more risky for that reason.

Upside profit is capped with NPs while remaining unlimited for long stock. On the whole, I don’t believe upside movement outpaces NP profit potential very often. This is why I consider long stock more of a gamble as opposed to the more consistent returns generated by NPs.

For those who conceptualize trading as a zero-sum game, the upside is where differences may be recovered. The few times the market goes up strongly and [far] outpaces NP gains makes up for the many times the market goes up a little bit, sideways, or down and the NP trade wins.

I think psychological comfort should be considered when comparing NPs with long stock. As mentioned above, I favor lower DD approaches because fear lurks on the downside. On the upside, greed can take over if I fail to keep pace. A market that remains strong for an extended period of time may cause NP traders to become increasingly frustrated. In a worst case scenario greed takes over, the NP is closed in favor of long stock, and the market proceeds to tank causing larger losses.

Remember the adage “you can’t go broke taking a profit.” I may not profit as much to the upside but I won’t go broke and I will continue to make consistent profits. Anybody who gets so restless and agitated because they aren’t making as much should think about what happens when times flip and the market heads lower. Don’t get caught up in the greed because nothing goes up forever.