Back in 2006, when I was introduced to options trading, the first thing I did was to hit the library to find out more about this exciting financial product.
I forgot the title of the first book I read, but I remember it gave a very simple and nice introduction to what options are. One thing I distinctively remembered about that incident was that after reading the book, I thought to myself: “Why are options considered dangerous?”
I mean, since options are much cheaper than stocks themselves, and the most you can lose is the premium you paid, why are they dangerous? Aren’t they the safest way to bet in the stock market? Yet, I also recalled how Nick Lessen broke Barrings, since that happened in my country, Singapore… I left the library feeling perplexed, but nonetheless hopeful… I guess, like many other newbies, I was “lured” by the concept of limited risk, unlimited potential… Years later, I would reflect on that moment and laugh at my own naivety….
Coming from a mathematical background, I understood the concept of leverage easily. I understood how leverage can be risky, so I figured that I would only buy one lot each time. Even if I lost 100% of my premium, it would only be a small percentage of my account… However, what I did not understand at that point was how the odds are heavily stacked against an options buyer….
Now, I understand that buying options is pretty much like buying lottery… both promise a CHANCE to win big with only a small investment… but the chance of winning is so slim that eventually in the long run, we’ll end up losing…. we may convince ourselves otherwise, thinking that with all those fanciful technical analysis, we are not gamblers… but that is so wrong…
If we consider the odds of buying options, we’ll realize that 80% of the time, options expire worthless. As an options buyer, you only have a 20% chance of winning…. that means, your average profit must be 4 times your average losses in order for you to just break even… and that is without considering commission… if you add in commission, your chance of breaking even is even smaller…
In contrast, an options seller is like the lottery company, they can afford to pay out millions of dollars to winners each month, because only a small (probably negligible) percentage of lottery buyers will win… the odds are so much in their favor… the amount that they collect from those who lost, more than cover for the winning payout… Similarly, options sellers have a high chance of winning, and their frequent profit will more than cover for their occasional losses…
I learnt about the odds of options trading for some time before I fully appreciate it… In the beginning, I traded options like stocks, buying CALLs and PUTs to bet on the market direction… I won some, I lost some… but after 1 year and $1000 down, I was finally convinced that options buying is too difficult a game for me… To win, you need to be right about the direction AND the timing… Now, I don’t predict market direction… I spend less than 15minutes trading each night, and after selling options for about 6 months, I’ve made back what I lost and some more….
So to answer the question in the title…. SELL!!!
