Options Trading Explained: Casino Correlations | tradeTALK Series
Mar 22, 2021
By: Mike Butler
Options trading is a complex endeavor, but we can simplify things for options trading beginners by taking a look at how buying options compares to selling options, and compare these ideas to players in a casino. tastytrade’s Anton Kulikov explains in his TradeTalk, “Be the House.”
When you walk into a casino, you are typically one of two types of players. You are either the typical gambler, who has an allotted amount of money they plan to potentially lose, with the small chance of hitting it big at one of the tables or games. Alternatively, you may be a player that plans to win over time by way of risk management, gaining a statistical edge in some way, and using the probabilities to your advantage.
The former is typically reserved for games like roulette, slots, and any other game that has an expected loss in the long run for you, but offers huge odds if you get lucky. In a weekend you might make some money if you hit a nice win, but in the long run over a large number of occurrences, the odds are not in your favor.
The latter is typically reserved for poker & blackjack players, where statistics, probabilities and risk management are imperative to be successful. Over the long run, you can be profitable playing these games if you understand how to manage risk and put yourself in high probability situations.This also applies to the casino itself - there is a reason casinos flourish when activity and volume is high inside the casino - they expect to have big payouts every once in a while, but over the long run, their odds are set to churn a profit for the casino in the long run.
When trading put and call options, the arena is not much different than a casino - you have your option buyers that are limiting their risk for a chance at a big win by betting for a stock moving in a certain direction in a limited amount of time. In the long run though, if those options purchased are held to expiration there is a negative drag on expected value, as options held to expiration must acquire or retain intrinsic value to make up for the extrinsic value lost over time. If this doesn’t happen, the options will be worthless at expiration.
On the other hand, you have your option sellers that give up the home-run hits in exchange for a high probability expectation of making money in the long run. These traders are betting against the stock moving in a certain direction, and because of this they have a high probability of making money over time - they no longer need the stock to move in a particular direction, they just need the stock to not move beyond their strike price.
In a way, OTM (out of the money) option buyers can be tied to the gamblers in the casino, and OTM option sellers can be tied to the poker players, blackjack players and casinos themselves, that expect to win in the long run with great risk management and high probability trades.
The business concepts you must master to make sure your account grows over time are similar to those that casinos have to execute to limit their exposure. Some of these include:
Table minimums AND maximums (Trading Small & Sustainable Strategies)
Keeping individual trade risk small, so that no one position can wipe out or devastate the account
Spreading risk through time for sustainability.
Trading strategies that have been backtested and show potential profitability through all environments
Betting diversification (Bullish, Bearish, Neutral Options Strategies)
Utilizing different strategies for different IV environments and expiration dates
Being able to articulate bullish, bearish and neutral assumptions through diverse strategies
Keeping people playing longer to boost their number of occurrences, so that expected probabilities start to align with realized probabilities.
Generating a high number of occurrences over time, so that probabilities associated with options trades have some time to normalize.
When trading options, you are able to not only invest in a game that can be profitable over time, but you can control how much risk you are willing to take to make a certain amount of profit. The key is to limit your exposure at any given time and trust that even in the depths of a losing streak with high probability trades, eventually you can come out on top if you trust in the math associated with high probability trading, and overstated implied volatility. Check out Anton Kulikov’s tradetalk to learn more!
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
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