>The nice thing about options is that there isn’t just one way to lose money. No, you can lose money in many different ways – far more than I can write on this page.
This is the most important lesson of options. It's never just a coin flip. You have an unimaginably huge number of factors riding against your success. It's not even remotely close to a 50/50 win/lose scenario. There are a million ways to lose, and just a few narrow ways to win. You literally have better odds going to the roulette table and placing a bet on red.
E.g. If I am net long in my portfolio and I fear some headwinds I can buy a put or two for the peace of mind. Now those puts should be always considered as worthless, and it is just the price to pay for the peace of mind.
Similarly you sell options. Trading options on the other hand is just pure gambling. Even if you get the direction right you likely won't get the timing right (or the volatility).
> E.g. If I am net long in my portfolio and I fear some headwinds I can buy a put or two for the peace of mind. Now those puts should be always considered as worthless, and it is just the price to pay for the peace of mind.
Why don't you just change your allocation?
If you can't sleep at night because of your current portfolio, and gyrations that are occurring, or that you are worried could occur, I would say it's obvious that it's not suited towards your risk profile.
You're burning up some of the potential upside by spending money on the options, so why not simply take some money off the table instead and have a less complicated setup?
Year ago when we were reading the news about what is happening in Wuhan, some of my friends bought SPY puts as an insurance against the potential crisis.
The best outcome for them would be if those puts expired worthless. When you insure your house, you don't usually wish for it to burn down.
I haven't acted and my portfolio took a -30% hit right after.
Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. That strategy has an unlimited loss potential[0] if the stocks rise before you buy them back. With puts you are limited to whatever you pay for them.
edit:
[0] unlimited loss potential provided you want to keep the same stake at the companies
Rebalancing is a thing, though generally for risk reasons. It would/could have saved one's returns during the so-called Lost Decade of the 2000s with the S&P 500:
As your equities dropped, there's a good chance bonds would have at least stayed neutral, or even risen: so you'd sell some of those (sell high) and pick up equities at a discount (buy low).
There are even products available that do this automatically for you:
>When you insure your house, you don't usually wish for it to burn down.
You're leaving crucial information. You don't buy insurance (or puts) at any price. It has to make economic sense, and the person on the other side presumably has the same information.
Of course, being safer (more conservative) brings lower profits. I'm for sure not suggesting to be puts-insured all the time! It is just a useful instrument when one wants to hedge.
The person on the other side is likely a market maker selling both kinds of options. The price is dictated by market.
It's unlimited opportunity loss. If you sell at say $100 and it goes to $1000 while you're in cash, you "lost" $900 vs your original position. However if you hold at $100 and buy a put for $2 that hedges you, you can still participate in the upside while limiting your downside. Also, downside risk has been historically undervalued (this may be changing though) which is why tail risk funds exist.
everything has an unlimited opportunity loss though. if I put all my money in SPY, I'm forgoing the "opportunity" to buy a bunch of OTM gamestop calls at the perfect time and 10x my net worth.
The strategy forces you to time the market. You might get unlucky by holding cash during a market rally, then buy back for a dump.
An investor who sells when they think the market is going to go downhill, with the intention to buy back later is not acting as an investor but as a trader.
That's why hedging with options is less risky (and less profitable in the best case).
edit: My use of word 'unlimited' applies if you want to keep the same stake at the companies. In money terms you cannot lose more than the value of your holdings.
Yep, then I agree. I'm not advocating for trying to time the market, or holding cash instead of being on the market.
But selling your position simply does NOT mean you take on "unlimited loss potential". It's simply being outside of the market, which means you're missing out on gains. It's not like selling stock is suddenly the same as shorting the same stock. I think the terminology here is clear-cut and well established.
I get what you're saying and I think your terminology makes sense.
But the way to understand this is to reframe your view of "money" from being some special, neutral thing to just being another asset.
At any given moment, you could own $1000, or some gold, or some bitcoin, or whatever else. There is nothing special about the fact that it's $ you're holding rather than DOGE or SPY.
So imagine a 2-asset world, that has SPY and $ in it. You are holding $1000 right now, and the market goes from 1 SPY = $1 to 1 SPY = $1000. That is a loss. Denominated in SPY, you just lost 999 SPY.
It’s unlimited because in the time he is holding cash there’s no limit to the amount the stock market could increase. If he sells a stock for $10, and then it goes from $10 to $10,000 he’ll only be able to buy back 1/1,000th of what he had. He lost $9,990.
It’s the same as writing call options. There’s defined upside and unlimited downside.
> How does holding money have an "unlimited loss potential"? You just buy back at whatever value the stock is at the time.
It does not have unlimited loss potential, I'm not sure why the poster said it did. It's the opposite - holding has unlimited upside potential(however slim).
People don’t realize you have unlimited loss potential on every stock you are not holding right now, and that’s why cash is not a great position. When you sell and wait for a dip, you are basically in a short position except you’re not borrowing stock.
I had SPY puts expiring in April at the same time, but as a hedge against Bernie Sanders doing unexpectedly well on Super Tuesday. He didn’t, but my timing was still good against a factor that I had been entirely ignoring.
You can also write them in a low risk way for the benefit of others. If you hold some stock write options for people to buy it off you for twice what you paid, or if you are thinking of buying a stock write options for people to sell it to you at lower than the current price. But yeah trading can be iffy.
The problem with covered calls is you take on all the downside risk of the stock collapsing and get none of the upside gains if the stock rockets. Writing way OTM covered calls will not net many proceeds unless the stock is super volatile which means you likely have a lot of downside risk.
A good example from recently is Ford. Was trading at around $6 a few months ago and not too volatile. OTM calls were pretty cheap that were a few dollars up and essentially worthless at double the price. Anyone writing those was getting almost no premium. But then the stock took off quickly and hit over $12. Anyone who wrote those calls enjoyed none of those gains.
So even a stock like $F can move in very unpredictable ways.
Why would an option ever be 50/50? You are getting the odds you pay for...
On a double zero roulette wheel, you have about a 47% chance of hitting red. There's options I'd buy at that price, and options I wouldn't. With options in particular you also have your various calculations regarding time, volatility and so forth.
But you can be pretty sure if an option is being bought and sold, that the buyer and the seller are pretty happy about the price of it...
I think the OP is pointing out that many people think of options as a bet on stock price movement with the probability of success being the probability of the stock moving.
When in fact volatility, time decay and many more factors are really shaping the success probabilities.
Agreed all those factors go into the value and it's important to understand what you are purchasing.
At the same time it is a leveraged position. If winds tilt in your favor you have the option for 100 shares of the underlying for only the cost of the premium.
> It might also be true that neither the buyer not the seller, in any transaction, are happy about it as such.
"Happy" here is used in a very specific sense: If two parties engage in a transaction without coercion, it must be because they are both made better off by the transaction or they would both be less happy without the transaction.
This is where "gains from trade" come from.
The ability to make this statement disappears the moment either or both parties are required to participate in the transaction or are required to engage in different transaction.
The argument of the grandparent is that just like in any transaction, there are two parties to an option being traded at a given price. One party believes it's a good deal because they think the price they paid is low enough to accept the risk-reward balance and the other part believes the price they received is high enough for the certain payoff to cover the reward-risk balance they are giving up.
They might both be right because the reward you seek and the risk you can bear is a function of your current endowment in human and financial capital.
"If two parties engage in a transaction without coercion, it must be because they are both made better off by the transaction or they would both be less happy without the transaction."
That's is about as accurate as physics homework you do in school, two objects collide without friction and air resistance, no energy is lost to sound, heat or deformation of the objects, calculate their resulting velocity.
As soon as you enter the real world and those objects are cars, equations aren't remotely accurate.
Any layman can come up with examples where this statement doesn't hold, drugs, etc.
We should focus on discussing real-life effects of options trading rather than spouting free-market theory clishes, everyone knows them, there are at least 3 such statements in every HN thread and I don't feel they contribute much to the coversation
I can support my point with decades of data that average retail investor only looses money. I can support it with recent barrelrolls that GME price was doing, with 2008, etc.
Our societies literally have enshrined in law that most people cannot be trusted with financial instruments.
I think I understand where you're coming from now.
You're saying that even although both parties are happy with the trade they made, when one party is a professional and the counter-party is an amateur, the amateur is likely misguided and has a much higher chance of getting the worse end of the deal.
That seems very likely to be true and applies to much more than just stock market options. Salary negotiations have that imbalance of knowledge/power as well. Probably even dating follows that pattern if one partner is much more experienced than the other.
Is that a fair characterization of your argument?
I don't actually see a problem here though - I mean it's pretty obvious professionals beat amateurs at just about anything. I don't think we would want to make rules to prevent the amateurs from playing the game. There are already some rules to restrict access to e.g. margin, naked options trading by amateurs - are you saying we should have more regulations and restrictions on the little guys for their own protection?
Earlier last year around May, when the stock market seemed to pick up after the COVID crash, I purchased a number of deep OTM LEAPs (long expiry options; until early this year). They were incredibly cheap. I often had trouble finding a market maker for those.
I only chucked about $2000 in, but these options have grossed $15,000 in realised returns and $25,000 in unrealised returns.
Options allowed me to make a “bet” that stocks would go crazily up. Options can be a valuable tool if you know how to use it.
Of course money is made. Likewise the same amount of money was lost by the people on the other end. You won this one.
However, long term you’d also lose some and in the end you’d probably be about even in terms of cash won and cash lost. Unless you’re an options guru which I don’t know exists. The market maker who gets the contract fee and hedges the contract is the only guaranteed winner long term.
Saying that I trade options when I sense opportunity and have had some outsized winners compared to my losers. However taxes need to be considered too, especially when you have a year with a net realized loss that’s greater than what the IRS let’s you deduct.
The way I’ve seen people get wiped out with options is not managing their bankroll. They’d have just too much of it spread across numerous options bets thinking they were diversified. And then the bottom falls out of nearly everything and the whole thing goes to 0. It happens.
I've been looking into 12 / 18 / 24 month calls for Tesla, AMD, NVDA, AAPL and there is nothing cheap available anymore, even the really OTM stuff.
There was some stories about 12 / 24 month sub dollar OTM Tesla calls that printed between march and the split, but alas, no such things anymore. There are some deep ITM prices that sell for around the delta, but then might as well buy the shares.
I think it is rather well known since Taleb's book came out that deep OTM options, including LEAPs tend to be mispriced as there's just not enough data to model better pricing.
Might also be one of his other books like Black Swan (I haven‘t read them all), but I think Antifragile mentions using options to mitigate risk in a portfolio.
Congrats! I sometimes will do what I should not do and do regret day dreaming of if I had done more than just think about what you actually did back around same time.
My original thesis was that the coronavirus may continue to grow and impact meatspace businesses for years (like until 2023), and hence tech stocks like Google, Facebook, and Shopify has huge upside.
I also reinforced this viewpoint with “momentum”: academic studies over centuries show today’s winners are more likely to be tomorrow’s winners.
It really depends on how you use them. My favourite strategy is to identify a stock I want to own, enter the market by writing a put at a price I want to own the stock at, and then if executed (and the stock price hasn't crashed), write covered calls at an inflated strike price. If the price goes down you can buy back your call and lock in your return, and write another call. I only do this on European style options to limit risk.
Assuming your stock selection criteria is sound, you can make money when the market is moving sideways or going up. When markets are down you wait it out. If your stock selection was sound, your stocks will recover when market sentiment becomes rational.
Having said this, you have to stick to the trading plan. You need to know when your trade assumptions are wrong and what to do prior to having to deal with a trade that goes against you.
That's the reason why it's "hard" and people loose money... it's not options per se, it's the personalities that trade them that are the problem.
No, but I will. Thanks for the recommendation! Currently I'm reading Mark Jeavons -
The Equity Edge: A complete guide to building wealth through the stock market. It so far has helped me improve my stock selection.
Even though I agree options is generally a losing game, it does serve a purpose. You can actually even hedge your risk with options -- there are many usages, just because SOME people use it as a casino, it doesn't mean it is.
A lot of hedging companies do to raw materials, oil etc follows a similar pattern.
The author doesn't mention anytime that, he seems clueless, just use it to play like casino and complain about the losses.
People often think of options as a cheap shortcut to wealth. They end up losing everything with that strategy. No one becomes wealthy in trading with one-off trades.
Trading options effectively and sleeping at night starts with studying and monitoring 30-50 underlying securities across different sectors, understanding their price action, liquidity, binary events, current volatility (both relative to their own volatility range and to their markets’ volatilities), the effect of that volatility on expected prices, and how these underlying selections balance a portfolio’s risk and expected moves. Of course there’s a lot more to it beyond that, but having that list helps you pick an underlying to play with at a given moment.
There are many strategies of options trading out there for managing risk while making money in every kind of market. If you’re intellectually curious about options, don’t take tips and lessons from people on Reddit, twitter, or hn.
Why do people spend years honing a craft like software development yet spend no time vetting symbols they hear about online before dumping money money into trading them? How is that acceptable?
If anyone is intellectually curious about this, I suggest they go to YouTube and start by watching tastytrade’s videos as well as basic introductory videos on option definitions, mechanics, and strategies.
Correct - some options have a more than 50% chance of winning and some much less. They are priced accordingly. In theory, options are priced such that you’ll break even (minus contract fees) long term in terms of money in and taken out. Of course bankroll management is a concept I’m not sure the YOLO crowd is too cautious about.
What people can't accept is that there IS some people who have made consistent gains on options. You just don't have play all the time and you should always have many factors lined up to you.
tbh, the problem with options is that you can loose a lot of money that you don't have.
People start to play with strategies without fully grasping how they work, and especially how exposed you are if you sell naked options. It's very easy to fall into the trap of creating an option strategy that even if it has good odds, will require a massive amount of margin.
If this happens to you on a regular retail account, you're going to get crushed.
This is easily avoided by not writing option contracts. If you're new to options and are ready to start exploring with real money, you should only be buying them and then selling them, not writing new ones.
The exact same thing can be said for shorting stocks and, to a lesser extent, buying stocks on margin. I'm happy to say after getting margin-called in 2008, I haven't been since! Writing options and shorting makes you way more likely to expose the rest of your portfolio to that risk.
You can write spreads and not have infinite downside risk. Iron condors are designed to collect premium and you’re covered (at a loss, but a fixed loss) if the stock goes one way or another too far. Of course at that point we are already more advanced than a YOLO casino roller.
But yes, in general it’s wise to avoid bets with infinite downside and limited upside. You tend to win these bets frequently (and make small gains) but when you do lose it’s catastrophic.
I would like to add that even with a spread you can bankrupt yourself if you are assigned to one side of the leg on expiration day after hours, stock moves against you, you aren't notified in time and therefore can't exercise the other leg.
>There are a million ways to lose, and just a few narrow ways to win.
I'm not sure I understand. You can take either side of the trade you want, so if you think you've determined how lopsided it is, why aren't you doing the opposite trade?
I'm not sure how that is relevant. The price of the option will decay to zero or to its intrinsic value and if it ends in the money one side will give $X to the other at the end. Someone also paid a premium to the other (ignoring the bid-ask spread and transaction costs). Peter's gain is Paul's loss. You have 50/50 probability of being Peter or Paul.
This is the most important lesson of options. It's never just a coin flip. You have an unimaginably huge number of factors riding against your success. It's not even remotely close to a 50/50 win/lose scenario. There are a million ways to lose, and just a few narrow ways to win. You literally have better odds going to the roulette table and placing a bet on red.