Cam Hui writes about the risk of chasing high option premiums when doing buy-writes (link). Similar caveats apply to those chasing high yielding stocks.
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the lure of free money brings out the worst in people. I think that one key area of that is the seeking of yield.
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I've been burned more than a few times chasing premiums. The most memorable was one time I escaped, and that was the weekend before Lehman. The stock was trading in the 30s, and front month LEH 10 puts still had decent premium. I figured it was "free money," I mean Lehman wasn't going to go from 30 to 10 over one weekend? Well, it went to about 3 the next week. It was a valuable lesson, and that particular one didn't even cost me anything.
Sometimes the market knows more than is being revealed. The closest thing to a free lunch might occur when Barrons or some brokerage house recommends a specific option trade at specific strikes. A bunch of newbies see that and get in, and pay up. Get on the other side and it is typically only a few bucks of extra premium, but it is often enough to buy that happy meal.
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