Right after I was promoted to first lieutenant at the Pentagon in 1987, a contractor talked to me about a job.
He was ready to hire me as soon as I got out. I politely listened. But I was terrified on the inside.
Becoming a contractor was a fine career path. It was typical for those in the military – spend some time in uniform, then trade in your fatigues for a button-down and a desk. It would mean a life of comfort, safety, and relatively high wealth.
But I knew it wasn’t for me. I was too used to working in the field, on deployment. Where my decisions carried weight, and I had a sense of great personal responsibility.
A cushy desk job didn’t track with that.
Thankfully, I had a backup in mind.
How I Chose Trading
I’d been learning about the stock market from military officers and civilians nearing retirement. Several mentioned dividends. They planned to live solely off their pensions and dividends, leaving them free to do whatever they liked with the rest of their life.
Becoming a contractor sounded fine, but doing whatever I liked sounded even better. Even better, investing in the market to achieve this goal would give me that same sense of responsibility I felt when I was in the field.
So I planned for that “career path” instead.
I didn’t know much about the markets at that time. All I knew was that if you invest, you eventually retire rich. So, I started buying stocks with good dividends and figured I was well on my way.
A few months later, the S&P 500 dropped over 20% in one day. I quickly understood I needed to learn more.
But my learning style is different from most. I don’t want to know what everybody knows. I want to know what the pros know.
Before buying my first house, for example, I took the real estate exams. When I had a family and needed insurance, I took the health and life insurance exams. By then, I’d already earned my property insurance license.
To learn the stock market, I started with the stockbroker exams. From there I moved on the Chartered Market Technician exams. Within a few years, I had the book knowledge of a professional.
But in those years I spent getting the education that would prepare me for my second career, I learned stocks would not provide the income I needed.
Dividends sound nice. But dividend stocks carry high risks. A large loss can destroy everything you earned from the dividends. It can take many years of small dividends to get that capital back.
That realization pushed me toward active trading instead. There, I saw another problem with stocks.
Great stock traders only make 20% to 30% a year. It takes a lot of money to live off trading gains. I did okay for myself, but not enough that a 20% to 30% yearly return on capital would float me.
So I looked to other markets to help solve that problem — namely futures.
Finding the Right Leverage
Futures offered the chance to trade with leverage. That means small percentage moves could result in outsized gains.
That promise is still available today. But futures aren’t right for everyone. In fact, they aren’t right for most people.
Risks in futures trading are high — higher than almost any other derivative market. When trading futures, you can lose much, much more than you invest.
A nice example of the risks and rewards came early in 2022.
After Russia invaded Ukraine, the price of nickel soared. Before the war, the margin for one contract was about $12,000.
If you were long nickel, you made over $430,000 on that $12,000 investment in two days.
(Click here to view larger image.)
Before you rush out to open a futures account, remember there are two sides to each trade.
If you were short nickel, you lost over $430,000. Prices fell quickly, so if you were able to hang on, the loss would have been smaller.
That’s a big “if.” Another big “if” was whether you could even close your position in either scenario.
For several days, nickel futures were locked at a single price. This happens in futures markets during times of extreme volatility.
When this happens, futures traders are all trying to get out of trades and there aren’t enough buyers to meet demand. The price is locked for the day and trading stops. In nickel, the locked price was still $114,000 above the level it traded at before the spike.
If you were on the losing side of this trade, you faced a margin call. Your broker demanded more money. If you didn’t have it, they closed your position, and you then owed them money.
And even if you were on the winning side of this trade, you might not have been able to sell. Trading was locked for two weeks. When it resumed, the big gains were gone.
This is an extreme example. It shows why futures aren’t for everyone.
Fortunately, there now exists an alternative that provides sensible leverage, and built-in risk management. It allows a trader to actually generate enough profits each year to fund a comfortable retirement.
If you’ve spent any time reading this newsletter, you know where I’m going with this.
Options markets are the best they’ve been since they hit the public markets in the early ‘90s. They are liquid, trading is cheap, and there are countless tools at an investor’s disposal to responsibly and quickly grow a portfolio.
Best of all, they offer leverage. An option might cost less than 5% of the stock price. Yet it can still move hundreds of percent on the back of a move 1/20th the size of the stock.
Options give you the chance to generate large returns from small amounts of money. And that’s why I wound up settling on them as my primary investment tool.
Michael Carr, CMT, CFTe
Editor, True Options Masters