Option Selling Defined - 015
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I realized that we have done many episodes already where we talk about why you should be selling options, but never gave an explanation.
Option sellers trade in a market neutral way. So you don’t need to market to go up or down. You can trade it when it doesn’t even move.
Also, option sellers have probability on their side. So we do trades that have for example a 70%, 80%, or even 90% probability of working out in our favor. These calculations are done using sophisticated statistics and mathematical formulas that won the Nobel Prize.
In addition, to be even safer, we use other risk management techniques like stop losses, and spreads which limit our losses.
And the example given was the insurance company. So just like the insurance company collects premiums so do option sellers.
In fact, the insurance company analogy is a great one.
Because as well talked about in 8, the real reason options were created were as a way to lose money. They were created as a hedge. As insurance.
So the option seller acts as the insurance company be selling options to farmers, manufactures, and investors who are looking to protect their positions.
That’s one way to describe the option seller.
The second is as a casino or more accurately as the house.
The house takes bets from gamblers and has the odds in its favor. Over the long run, the house always wins.
For us, the gamblers are called speculators. These are the option buyers who are betting against the odds hoping for a big payday. Kinda like lottery ticket buyers. The option seller is the house, and takes the other side of the bet. Once in a while, the option seller loses, but over time, the house always wins. It’s just math.
And with the odds in my favor, I don’t care which way the market goes.
I don’t have to predict. If I want to do a bullish trade, I can, but I don’t have to be right to make money.
This removes so much of the stress.
When you have a 70, 80, even 90% chance of winning on a trade, you don’t have to be the best trader in the world to make money.
You see, when you buy a stock it has to go up for you to make money.
And if it does not, then your money is just sitting there not earning anything. Unless it’s a dividend stock and you get some measly return like 2%.
And if it goes down then you lose.
You have to be right about the direction.
It is the same with buying options, except it is exponentially harder
Not only do you have to be right about the direction, but you have to know by when the move will take place, and how much the stock will move. If you are wrong on any of those three elements, you lose.
Here’s the magic:
When selling options, you get to play a range. The stock does what it does and as long as it stays in the range you want, you win.
Let’s use golf as an example.
To make money with stocks you have to get the ball into the hole in 3 strokes.
To make money by buying options you have to hit a hole in one.
To make money by selling options you just have to hit the ball onto the course.
One additional point I want to make is that emotionally, winning more often does wonders for your self-esteem and confidence. And as a trader, having confidence in your trades and yourself is a key factor to success.
Because with selling options, what we are doing is hitting base hits. Over and over. Not trying to hit home runs. Because you know what happens to the guy who tries for home runs – he strikes out most of the time. And in investing, a strike out means losing money which is not a good thing.
The episodes continues with examples of. Listen to the whole thing to get the complete picture.
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