It is true to say you have a less than 50% chance of making money on options

[CXMelga 0]

Hello

I am new to this forum and just trying to learn about options, so my questions are basic

There is a saying 'the house never loses' (e.g. casino) why because they have a greater than 50% chance compared to the customer e.g. 54.5% casino 45.5% customer

Therefore if I think about this logically a stock option is a derivative of the under laying stock so I have the same change of getting it right buying options as I do buying the underlying stock. So lets assume I pick stocks at random that would give me a 50% change or getting it right (like flipping a coin)

However, options have an expiry date, which I believe means when they expire they are worthless

Therefore it looks to me like I have a less than 50% change or getting it right with buying options e.g. I have two things against me  (1) 50% change of choosing the wrong stock (or in this case call or put option) and (2) time e.g. my option is eroding in value in line with time. So two things against me and one thing for me = less than 50% chance of getting it right, is that correct ?

if that above is logical (makes mathematical sense), why not just buy the stock ? for example if I buy the stock at $100 per share and it goes down to $80 I have lost $20 (e.g. not my whole investment) but if an option expires and it is not sold (or can you always sell an option regardless of market conditions)  I lose it all. Whereas with a stock I could hold for as many years as I like and chose the time I want to sell (I am not constrained by time e.g forced into a buy or sell because time is running out)., is that correct ?

or can I use the fact time is running out on my option to my advantage somehow ?

Thanks very much, I know these are basic questions but would appreciate some help to get me started learning

 

CXMelga

[Kim 7,943]

While theoretically this is true, there are many strategies where you can put the odds in your favor. You just need to know what you are doing.

[TrustyJules 3,212]

You should really start by reading a few basic books or websites regarding options. The fact you begin by comparing stock options to a casino indicates that there is a fundamental misunderstanding about these instruments in your mind. With options it is in fact quite easy to set up a trade that will be 85% in your favour but risk and reward go hand in hand. The 85% chance of a small to modest profit is matched by a 15% chance at a big loss - probabilities in options trading are the very basis of the pricing.

The questions of whether to buy the stock or the option is again a different one - options are not the same instrument as a stock and so its like saying : buy a house or rent a camper van? Options can be made to mimic stock and this for less capital lay-out then you require for stock. At its simplest options offer leverage that stocks never do. Say it is 2nd of April 2018 of this year and you want to buy TSLA and NFLX. You have 100K to invest in total.

Stock Purchase

NFLX @ 280$ is ca. 180 stock

TSLA @ 252$ is ca. 200 stock

Option Purchase

BTO 15 NFLX C JAN19 320 @ 31

BTO 18 TSLA C JAN19 300 @ 28

Skip to Friday last week

 

Stock sale

NFLX @ 374 $ for 63,000$ or 26% in just under 6 months

TSLA @ 264 $ for 52,800$ or just under 5%

Option Sale

STC 15 NFLX C JAN19 320 @ 69 for $103,500 or 108% in just under six months

STC 18 TSLA C JAN19 300 @ 24 for 43,200 $ or -14%

The options came out on top and I deliberately chose a winner and a bit of a dog of the last 6 months. Where you went away with a very creditable 15K profit on your stocks, your options brought in $46,700. The example is a little extreme and the trades that are discussed on here are not as purely directional as this one but in its simplest form this shows the power and risk of options. It amplifies your ability to profit and lose - if you understand something of the mechanics under the hood you can use what options offer you to your advantage and set up trades that are low risk and high probability or the reverse and everything in between. This is both the complexity and the beauty of the system as you can far better hedge your risks than with a straight out buy of a stock. The only place where the 'house' has the advantage is in the bid/ask spread which is a little churn you lose on every trade but that is also true on stocks.

 

[drcruz 116]

I'd you're just starting out go to Option Alpha and Tastytrade's "Where do I Start"

[Guest CXMelga]

Thanks 'all' for taking the time to reply, especially the comprehensive reply from TrustyJules that is very helpful. I have just ordered a book off Amazon and will read that cover to cover. I will also take a l look at the WEB sites drcruz mentioned and thanks to Kim too.

My basic idea is spend 'several months' in my spare time reading and learning (before I make any trades) about finical markets are options in particular. Then start is a slow way.

My basic goal is to come up with a potential additional income stream/hobby when I retired in about 5 years time (so thought better start learning now) using a percentage of my overall capital which I could afford to lose, and something I can do from any where with an internet connection. 

I did see one thing of great interest the other day called Iron Condor as if I understand the premise it limits your risk to a maximum fixed amount (e.g. amount you are prepared to lose). Whilst at the same time rather than trying to predict if X will go up or down you predict X will stay between Y and Z (but works best when volatility is high, e.g. get your timing right). It seems to me from a novice point of view it would be easier to get it right using this method (4 positions) while limiting my risk. Even if there are less opportunities over 12 months (conditions are right) so for someone just trying to make a bit extra income each year over several years I recon statistically I would have more change sticking to this Iron Condor approach.

Anyway loads to learn, looking forward to getting my book

CXMelga

 

[TrustyJules 3,212]

Good books about Iron Condors are by Kerry Given. The IC section here on steady options great too. An IC is exactly what I was speaking about when I said 85% chance in your favor. A classic trade is selling an IC on the SPY one (or two) SD out from the current position. and to do so 6-9 weeks ahead of expiry. You will have a defined income and defined maximum risk. Basically as long as the SPY stays within the short strikes you will make maximum profit near expiry. Heres an example (say its 1st of August of this year) you decide to trade the September SPY IC

BTO 1 P SPY 255 Sep21

STO 1 P SPY 260 Sep21

STO 1 C SPY 300 Sep21

BTO 1 C SPY 305 Sep21

net credit around: 26$ which is also your max profit (just over 400$ margin is blocked)  - your  max loss is 470$. Note that without a cheap broker this is a loss making proposition from the word go. However your probability is very high to succeed. Switch to Friday 21st September and we see all the options expire worthless and you keep the money you collected. Its generally advisable to close at least a week before expiry but this IC was so safe that it never got challenged during the whole period it was running. The max loss was a multiple of the profit and so some people say this eating like a bird and s* like an elephant or picking up pennies before a steamroller.

In the absence of knowledge on how to manage the minority of cases were things go haywire you will hit a max. loss twice a year presuming you trade every month. This loss will wipe out the sum total of your profits and so statistics takes its revenge by reverting to the mean: zero. The skill with IC is setting them up at the right time at the right width of strikes for the right premium and having a plan to avoid the max loss. I traded IC's for a year on a tiny scale (literally 1 option) to learn - I came out ahead every time. I then set up the trade at 10x the size which is what I would have been comfortable with for my portfolio - the very first time it moved against me real fast and though I avoided the max loss it wiped out all the profits before. The second one I set up - same thing - the market doesnt care about you or what went before - I recovered dont worry but its frustrating and eats at your confidence when it happens. Its always great to say you made a killing in the market but in reality that time you lost a bundle but not your shirt was more important.

[Guest CXMelga]

 

Thanks very much again TrustyJules  you are obviously extremely knowledgeable.

It will take me years to learn, but I will take a steady approach 

Thanks again

CXMelga