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Mar 30, 2016

Why Risk Does Not Mean Loss | Truth or Skepticism

By:Josh Fabian

Sometimes, the most passionate relationships are also the most volatile (that’s actually the recipe for a dysfunctional relationship, but I’m trying to be nice). Today’s Truth or Skepticism was as volatile as we’ve seen.

The battle of passive versus active money management is at the center of the show, or so we thought. Dylan has made the argument for passive investing a number of times. Where today’s argument became different was Dylan’s articulation of his view on risk. To paraphrase, passive investing likely leads to 3 or 4% returns in this market. But active management may result in potentially losing 50%. That stood out for both Tom and hopefully all tastytraders.

Actively manage and risk 50% your capital or passively invest and earn 3% - 4%?

Dylan’s statement about risk is a result is just old school finance mentality. Somewhere along the line, risk became synonymous with loss. However, that potential for loss is no greater than the potential for gain. Whether he realized it or not, Dylan perfectly summed up the sentiment of a risk aversion public.

Risk does not mean loss. What’s more, risk of loss exists in passive investing every bit as much, and arguably more, than it does in active management.

Passive investors have, at best, a 50/50 chance of making money. Those odds are actually worse when factoring in various management fees. For active investors, the odds increase because of factors such as timed order entry and mean reversion in volatility.  

Options expire worthless 90% of the time.

But in order for that to happen, someone has to be buying and someone has to be selling. Markets don’t sell options to investors on their own. When options expire worthless, that means those willing to take the risk of selling them are profiting.

It turns out Truth or Skepticism is not about active versus passive investing. It’s about reprogramming the false syllogism equating risk with loss.

Josh Fabian has been trading futures and derivatives for more than 25 years.

For more on this topic see:

Truth or Skepticism | Investing is a Level Playing Field: March 30, 2016

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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