Guru Grades

Steve Sarnoff's Advice at the "Options Hotline" (Last Updated 9/4/07)

A reader asked our opinion on the equity options trading advisory service offered by the "Options Hotline" via Agora Financial LLC. The "Options Hotline," edited by Steve Sarnoff, presents to visitors a list of short-term "trades" with triple-digit gains and tells them: "If you are looking to make double- and triple-digit gains in a matter of months, weeks or even just days, you've come to the right place." Is this representation realistic? Does the "Options Hotline" offer value to subscribers? Using some logic, the self-reported recommended buys from the "Options Hotline" for 2005-2006 and daily price data for the underlying securities from the day after recommendation dates through associated option expiration dates, we conclude that:

The note accompanying the list of extremely successful trades at the "Options Hotline" states:

"Gains are based on all triggered picks, assuming exit point at peak option value. Percent gain represents the percentage change at the subsequent high value, from the trigger price. Profit calculations do not factor in commission and taxes." [Underlining added.]

Said more plainly, reliably capturing the gains presented as examples requires perfect hindsight backwards from the option expiration dates to the option purchase dates (i.e., a time machine). Just about any trading system could produce fantastic gains assuming perfect hindsight. In reality, the probability of systematically achieving such gains is vanishingly small. The examples presented at "Options Hotline" seem designed more to mislead naive prospects than to educate visitors.

To dig deeper into the question of whether Steve Sarnoff's "Options Hotline" recommendations offer value to subscribers, we analyze a sample of 70 recommended buys (omitting those designated as"DID NOT TRIGGER"). Since we do not have options pricing histories, we look at the volatilities of the underlying securities to determine whether Mr. Sarnoff systematically recommends the "easy" side of options trades. In other words, when he recommends buying call (put) options, do the underlying securities show greater upside (downside) volatility by trade and on average from the day after buy dates to the option expiration dates? This analysis approach assumes that Mr. Sarnoff picks option expiration dates to exploit price volatility over the entire periods available. This approach is favorable to Mr. Sarnoff in that it ignores the time-value of options, which works steadily against options holders.

The following table summarizes the results of this analysis. For each of Steve Sarnoff's options purchase recommendations, it shows the unadjusted closing price of the underlying security on the next trading day. This price should be close to that of the security at the time the option is purchased. The table also shows the lowest and highest prices of the underlying security from that point through the option expiration date, and the associated maximum percentage downside and maximum percentage upside over that period. At the right margin of the table is a plus or minus sign to indicate whether Mr. Sarnoff proved to recommend the easy or hard side of the option trade. For example, if Mr. Sarnoff recommends buying a call option, and the maximum upside is greater (less) than the maximum downside in absolute terms, then he gets a plus (minus) for that recommendation.

A simple count shows that Steve Sarnoff recommends the easy side of the options trade only 43% of the time (30 out of 70). It appears that his method of selecting positions is not a good one. The size of the sample of recommendations is modest, so our confidence in this conclusion is not extremely high.

The following chart provides a broader perspective on the quality of Steve Sarnoff's advice. It shows the average maximum upsides and downsides from the day after recommendation dates through option expiration dates for securities underlying: (1) all option purchase recommendations; (2) put purchase recommendations only; and, (3) call purchase recommendations only. The chart shows that:

• There is on average more upside volatility than downside volatility for the securities underlying all of Mr. Sarnoff's recommendations, suggesting that one should have bought calls more often than puts. However, Mr. Sarnoff recommended puts 57% of the time, indicating that his timing of the the stock market in aggregate is poor.
• Volatility is more tilted to the upside for Mr. Sarnoff's put purchase recommendations than for his call purchase recommendations, indicating that his ability to predict the price behavior of individual stocks is not good. In fact, a trader buying puts (calls) when Mr. Sarnoff recommends calls (puts), would probably outperform Mr. Sarnoff's trades.

Again, the recommendation sample size is modest, so these conclusions might change with additional data.

In summary, the "Options Hotline" promotional verbiage seems intended more to fool than to inform, and Steve Sarnoff's method for picking option positions is probably ineffective.

This entry emphasizes the importance to investors/traders of understanding: (1) the statistics of variability; and, (2) the difficulty of picking exit points for holdings.

See Guru Grades for links to evaluations of the commentaries and advice of other investing experts.

See also Blog Synthesis: Equity Options for formal research on trading and hedging with options. Most of this research indicates that odds are stacked against long calls and puts and for short calls and (especially) puts.

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