Practice options trading zero sum games

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tastytrade is a trademarkservicemark owned by tastytrade. The new Firefox. Download Firefox — English (US) Your system may not meet the requirements for Firefox, but you can try one of these versions: Download Firefox — English (US) Your system doesn't meet the requirements to run Firefox. Your system doesn't meet the requirements to run Firefox. Please follow these instructions to install Firefox. Please follow these instructions to install Firefox. The best Firefox ever. Uses 30% less memory than Chrome. Truly Private Browsing with Tracking Protection. all things Firefox. If you haven’t previously confirmed a subscription to a Mozilla-related newsletter you may have to do so. Please check your inbox or your spam filter for an email from us. Advanced Install Options & Other Platforms. Download Firefox for Windows.

Download Firefox for macOS. Download Firefox for Linux. Download Firefox — English (US) Your system may not meet the requirements for Firefox, but you can try one of these versions: Download Firefox — English (US) Your system doesn't meet the requirements to run Firefox. Your system doesn't meet the requirements to run Firefox. Please follow these instructions to install Firefox. Zero-Sum Game. What is a 'Zero-Sum Game' Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. A zero-sum game may have as few as two players, or millions of participants. Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling are popular examples of zero-sum games since the sum of the amounts won by some players equals the combined losses of the others. Games like chess and tennis, where there is one winner and one loser, are also zero-sum games. In the financial markets, options and futures are examples of zero-sum games, excluding transaction costs. For every person who gains on a contract, there is a counter-party who loses. BREAKING DOWN 'Zero-Sum Game' In game theory, the game of matching pennies is often cited as an example of a zero-sum game.

The game involves two players, A and B, simultaneously placing a penny on the table. The payoff depends on whether the pennies match or not. If both pennies are heads or tails, Player A wins and keeps Player B’s penny if they do not match, Player B wins and keeps Player A’s penny. This is a zero-sum game because one player’s gain is the other’s loss. The payoffs for Players A and B are shown in the table below, with the first numeral in cells (a) through (d) representing Player A’s payoff, and the second numeral Player B’s playoff. As can be seen, the combined playoff for A and B in all four cells is zero. Most other popular game theory strategies like the Prisoner’s Dilemma, Cournot Competition, Centipede Game and Deadlock are non-zero sum. Zero-sum games are the opposite of win-win situations – such as a trade agreement that significantly increases trade between two nations – or lose-lose situations, like war for instance. In real life, however, things are not always so clear-cut, and gains and losses are often difficult to quantify. A common misconception held by some is that the stock market is a zero-sum game. It isn’t, since investors may bid share prices up or down depending on numerous factors such as the economic outlook, profit forecasts and valuations, without a single share changing hands. Ultimately, the stock market is inextricably linked to the real economy, and both are powerful tools of wealth creation rather than zero-sum games. ‘Zero-Sum Game’ Theory & Background.

Game theory is a complex theoretical study in economics. The 1944 groundbreaking work “Theory of Games and Economic Behavior,” written by Hungarian-born American mathematician John von Neumann and co-written by Oskar Morgenstern, is the foundational text. Game theory is the study of strategic decision making between two or more intelligent and rational parties. The theory, when applied to economics, uses mathematical formulas and equations to predict outcomes in a transaction, taking into account many different factors, including gains, losses, optimality and individual behaviors. Game theory can be used in a wide array of economic fields, including experimental economics, which uses experiments in a controlled setting to test economic theories with more real-world insight. In theory, zero-sum game is solved via three solutions, perhaps the most notable of which is the Nash Equilibrium, put forth by John Nash in his 1951 paper “Non-Cooperative Games.” The Nash equilibrium states that two or more opponents in the game, given knowledge of each others’ choices and that they will not receive any benefit from changing their choice, will therefore not deviate from their choice. ‘Zero-Sum Game’ & Economics. When applied specifically to economics there are multiple factors to consider when understanding a zero-sum game. Zero-sum game assumes a version of perfect competition and perfect information that is, both opponents in the model have all the relevant information to make an informed decision. To take a step back, most transactions or trades are inherently non zero-sum games because when two parties agree to trade they do so with the understanding that the goods or services they are receiving are more valuable than the goods or services they are trading for it, after transaction costs. This is called positive-sum, and most transactions fall under this category. Options and futures trading is the closest practical example to a zero-sum game scenario. Options and futures are essentially informed bets on what the future price of a certain commodity will be in a strict timeframe.

While this is a very simplified explanation of options and futures, generally if the price of that commodity rises (usually against market expectations) within that timeframe, you can sell the futures contract at a profit. Thus, if an investor makes money off of that bet, there will be a corresponding loss. This is why futures and options trading often comes with disclaimers to not be undertaken by inexperienced traders. However, futures and options provide liquidity for the corresponding markets and can be very successful for the right investor or company. It is important to note that the stock market overall is often considered a zero-sum game, which is a misconception, along with other popular misunderstandings. Historically and in contemporary culture the stock market is often equated with gambling, which is definitely a zero-sum game. When an investor buys a stock, it is a share of ownership of a company that entitles that investor to a fraction of the company’s profits. The value of a stock can go up or down depending on the economy and a host of other factors, but ultimately, ownership of that stock will eventually result in a profit or a loss that is not based on chance or the guarantee of someone else’s loss. In contrast, gambling means that somebody wins the money of another who loses it. There are other such myths regarding the stock market, some of which include: falling stocks must go up again at some point and stocks that go up must come down, as well as that the stock market is exclusively for the extremely wealthy. Your Intro to Options Trading: The ABC’s of Calls and Puts. Are you ready to start trading options?’ Then you’re in luck.

You’re about to get a 100% FREE crash course in options trading, comprised of 5 in-depth articles: You’re going to understand how options work in the real world without understanding complex math or financial theory. You’re going to understand vital concepts like implied volatility and time decay , and you’ll get 3 simple strategies that you can use to speculate on stock price movements. Contrary to popular belief, options are actually not that complicated. And they’re not inherently risky — you can take as much, or as little risk as you want. Are you ready to start learning? Derivatives are securities which are priced based upon the price of another security, like a stock, ETF, index, or commodity. And options are the best-known form of derivatives. In this series, we’re going to focus exclusively on options on stocks and ETF’s. Options represent the right but not the obligation to buy or sell a certain stock at a certain price by a certain date. And as the price of the underlying stock fluctuate, those rights change in value. A sports betting analogy can help you understand this concept.

An option is at its most basic level a bet on a bet. You’re betting that the value of the bet itself will change. Let’s say it’s the start of the NFL season, and we think the Green Bay Packers will win the Super Bowl. Options would allow us to bet that the value of a bet on the Packers to winning the Super Bown will rise or fall. If the Packers win their first 10 games in a row, that bet will be worth a lot of money. But if they only win 5, it won’t. Call options give a trader the right but not the obligation to buy a certain stock at a certain price by a certain date. All things being equal, when a stock price rises, the price of a call option goes up. Therefore, the buyer of the call option wants the price of the underlying stock to rise. Put options give a trader the right but not the obligation to sell a certain stock at a certain price by a certain date. All things being equal, when a stock price falls, the price of a put option goes up. So the buyer of the put option wants the price of the underlying stock to fall. Why Even Bother with Options? First, options require less capital to trade than stocks.

Let’s assume we’re bullish on Tesla. If Tesla (TSLA) is trading at $380, it would take $38,000 to buy 100 shares of the stock. However, we could buy a call option on Tesla for $2,000 or less, giving us exposure to 100 shares of Tesla at a low cost. So options give you a lot more bang for your buck in terms of upside potential. On the downside, options have a fixed expiration date. You can wait forever for a stock to move, but an option has to move in your favor quickly. (In a future article, we’ll explain the role of time in options prices.) Otherwise, it will decline in value or expire worthless, giving you a 100% loss. And that’s just long options. Shorting options — a practice we don’t endorse — is even more dangerous, and can destroy your trading account.

And that’s the trade-off: options require less capital and they have huge upside potential. But you also face serious downside risk. Another benefit of options is that they can be used to hedge an equity portfolio or individual stock positions at a reasonable cost. And finally, options are incredibly flexible. With options you can speculate that a stock will rise, fall, or even do nothing. Yes — you can use options to make money if a stock does absolutely nothing. We’ll be going over a method for this in the future. Strike Prices and Expiration Dates. All options have a strike price and an expiration date. If a person says “I bought NVDA $180 November calls,” they are telling you two things: They have the right but not the obligation to buy NVDA at $180 (the strike price) That right expires in November. And a person says “I bought TSLA $350 January puts,” they are telling you two things: They have the right but not the obligation to sell TSLA at $350 (the strike price) That right expires in January. Most options expire on Fridays at 4:00 p. m. ET. Large-cap stocks tend to have options that expire every week. Small and mid-cap stocks sometimes have options that expire only on the third Friday of each month.

The Basics of Options Contracts and Exercising Options. Most options contracts represent 100 shares. So buying 1 call option gives you the right to buy 100 shares. 2 contracts give you the right to buy 200 shares. To determine the dollar value of an option, take the current price and multiple it by 100. If an option is trading at a price of $1, it actually costs $100 to buy. As we told you above, when you buy a call option, you have the right to buy a stock at a certain price by a certain date. Let’s say we own 1 NVDA $180 November call. This means that at any time before the November expiration date, we can buy 100 shares of NVDA at $180. Assume NVDA skyrockets on earnings and hits $200. We can then do two things: We can sell the option itself for a profit.

Or, we can exercise our right to buy the stock, and purchase 100 shares for $180. That gives us an instant profit of $20 per share, or a total of $2,000. (minus whatever we paid for the call option in the first place) What Is an Options Contract? Options are not like stocks, which have a certain number of shares outstanding. Options don’t actually exist until a buyer and seller come together and form a contract. The term “Open Interest” describes the number of option contracts that are open at a particular strike an expiration date. If we say the October SPY $250 puts have an option interest of 20,000, this means that there are 20,000 contracts currently open. Trading Options Is a Zero Sum Game. There are two parties on every trade, and it is a zero sum game. If one side of the trade makes a dollar, the other loses it. You know how we had the right to buy NVDA at $180 at any time until the November expiration date? Well, there was someone on the other side of that trade that agreed to sell those shares to us at that price. We were the long side of the trade, and they were the short. We wanted the stock to go up and they wanted it to go down. Why?

Because again, it’s a zero sum game. If we’re making money, they’re losing it. And vice versa! Put options operate under the same concept, but backwards. The buyer of the put option wants the stock to go down. And the seller of the put option wants it to go up! Here’s a simple graphic that illustrates these relationships: Note: there are situations where options traders can make money even when stocks don’t move, but they’re beyond the scope of this article. We’ll delve into them later in this series! In the Money, Out of the Money, and Intrinsic Value. All options (both calls and puts) with a strike price very close to the price of the underlying stock are said to be “at the money.” So if AAPL is at $155, both $155 call and put options are said to be “at the money.” Call options with strike prices below the current price of the underlying stock are said to be “in the money.

” For example, if AAPL is trading at $155, all call options with strike prices below $155 are “in the money.” Here’s why: on expiration day, the right to buy Apple at $155 only has value if Apple is trading above $155. If Apple is trading at $160, and I have the right to buy Apple at $155, I’m a happy camper. The concept of instrinsic value is closely related. For in the money call options, the intrinsic value is the difference between the stock price and the strike price. If AAPL is at $160, call options with a $155 strike have $5 in intrinsic value. If a call option’s price is above the current stock price, we call it “out of the money.” Out of the money options do not have intrinsic value. However, out-of-the-money options are not inherently bad. They just require a big move in the underlying stock to pay off.

Here’s a table showing you at, in, and out of the money options on AAPL, assuming the stock is at $155: Let’s move on to puts. Put options with strike prices above the current price of the underlying stock are said to be “in the money.” For example, if AAPL is trading at $155, all put options with strike prices above $155 are “in the money.” This is because on expiration day, the right to sell AAPL at $155 only has value if GOOGL is trading below $155. If AAPL is trading at $150, and I have the right to sell at $155, I’m a happy camper. But if AAPL is at $160 on expiration day, having the right to sell at $155 is worthless! The concept of instrinsic value is closely related. For in the money put options, the intrinsic value is the difference between the strike price and the stock price. If AAPL is at $155, a put options with a $160 strike has $5 in intrinsic value. Theoretically, stocks have unlimited upside potential. The the same goes for call options. Let’s say KITE is currently trading at $60, and we purchase a $60 December call option for $5. If on expiration day, KITE is trading at $100 because of a takeover bid, that option will be worth $40. ($100 stock price minus the $60 strike price of our call option) So we paid $500 for an asset worth $4,000.

That’s a gain of $3,500. And admittedly, it’s an extreme case. But those are the kinds of profits most traders dream about when they start playing with options. Here’s a chart showing the potential P&L for the $60 call at each stock price: But remember what we said before about options being a zero sum game? Our $3,500 profit was a $3,500 loss for the person on the other side of the trade. This is why shorting options is so risky – you can take enormous losses. Now let’s examine another scenario. Let’s say we bought that same $60 December call option for $5. What if KITE is at $50 at expiration? Well, the right to buy KITE at $60 isn’t worth anything if the stock is at $55. So the option would expire worthless. The $500 we paid for the original option turns into a $500 profit for the seller of the call option. Now let’s look at the other side with puts. Let’s say BAC is currently trading at $25, and we purchase a $25 January put option for $3. If on expiration day, BAC is trading at $20, that option will be worth $5. ($25 strike price minus the $20 stock price.

So we put out $300, and now have an asset worth $500. That’s a profit of $200. But what if BAC went up, and reached $30 on expiration day? Our option would expire worthless, and the $300 we paid for our option turns into a $300 profit for the seller of the call option. Here’s what our potential P&L looks like on expiration day with BAC: Now, unlike call options, puts do not have unlimited upside potential. This is because a stock can’t go lower than zero. A $50 stock can only go down $50. But a $50 stock could theoretically go up forever. In our examples here, we made assumptions about options prices based upon expiration day to keep things simple. But options prices constantly fluctuate, and most options are not held to expiration. In the next 2 articles in this series, we’re going to dive into the most important factors that affect options prices, so you can understand why options prices move the way they do. The Misconceptions and Pitfalls of Options Trading.

They’re supposed to deliver you 1000% returns overnight, week after week right? That’s what a lot of these internet trading “gurus” will tell you anyway… But the reality is far different. Options are a zero-sum game. When one person wins, another loses. The winners are few. First you have the highly efficient market makers. These guys set market prices through their expertise in the Black-Scholes model used to derive an option’s price. They win in the long-term by controlling risk and collecting the difference in the bid-ask spreads. In exchange, they provide market liquidity. The brokerage houses win big too. They skim their cut off every trade and come out like bandits. And finally you have the “sharps” or the professional option traders that squeeze out a profit over time. Their method is the hardest to operate.

They aren’t rewarded for providing order facilitation services like the other two participants. Instead, they eat what they kill. Over the long haul they can get as rich as the other two, but only if they size up their method andor attract investor money. So who’s bankrolling these winning players? The suckers. The complexities of options are not well understood by most of the retail trading world. Nevertheless, they’re highly attractive because of their limited downside, unlimited upside, and embedded leverage. Who hasn’t thought about buying that call option on the hot biotech stock that returns 1000%? Or the way out-of-the money put on the SPY that triples a trading account in a nasty crash? We all visualize that outcome and crave it. The lucrativeness of the option market drives retail sheep to the slaughterhouse. They don’t know what they’re doing, and so they consistently lose, funding the winners. But you don’t have to be a sucker like the retail traders.

Options aren’t magic and they can be used to generate attractive returns. But they need to be used in the right way. The first step to successfully trading options is clearing up common misconceptions surrounding them. Misconception #1: Options Can Produce 1000% Returns For Your Account. We’ve seen it all before. And I’m sure you have too. Internet marketers advertising “1000% returns” in a few weeks on a call option. Or they pitch you on some trade idea that will make a 500% return if XYZ stock crashes. This sounds amazing to uninformed investors whose 401k’s have been clocking in at a measly 4% the last few years. Their greed emotions start to run wild. They tell themselves things like: “Imagine what 500% or even 1000% returns could do to my portfolio!

If I bet $10,000 that could turn into $50,000 or even $100,000!” Unfortunately these emotional traders set themselves up for disaster. It’s true that options can 5x, 10x, or even 100x in extreme situations, but these events are rare. And when they do occur, you need impeccable timing on both your entry and exit to realize gains of that magnitude. The options that can earn huge returns are the “out of the money” options. They have a strike price higher than the underlying for calls, or lower than the underlying for puts. Refer to the option chain for Apple stock below: At the time of this screenshot, Apple was trading for $97.14. The calls are on the left side of the table and the puts are on the right side. Every option shaded blue is considered “in the money”. Every option shade black is considered “out of the money”. The expiration date for all these options is July 15, 2016. The strike prices are in the middle (the gray area) and to the sides are the prices of each individual option.

Now let’s zoom in a bit and focus on one of these out of the money options. Check out the 85 puts: You can see the bid is $.19 and the ask is $.21. To the right of that is the implied volatility (IV) — the option market’s prediction of the underlying’s future volatility. And the next column is the probability that the option will expire in the money. The last column is the delta of the option (the Greeks are a discussion we’ll save for another time). The marketer’s pitch of 1000% returns on these options isn’t false, it’s just unlikely. The options that 10x, like the 85 put in Apple, can go from $.20 to $2.00, but the probability is extremely low. The option market is only pricing in about a 6% chance of that option making any money at all by expiring in the money. But to get that fat 10x return you not only need the option to expire in the money, you need it to expire $2.00 in the money. That would require Apple to close at $83 by expiration. Apple’s price would have to drop $14.14, from $97.14 to $83. That’s a drop of almost 15%! And all within the next 30 days according to these options’ expiration dates. Trying to hit that scenario reduces your chances far lower than 6%. Now those emotional investors might argue that their guru KNOWS Apple is going to fall by that much in the next 30 days. The option will definitely finish up 900%.

And so they load up their account. If a guru could predict a 10x move in an option with 100% accuracy, he would not be telling you about it. Some quick math should leave you highly skeptical. Why? Because even if he started with $10k, he would be a billionaire in just 5 trades. And forget 100% accuracy, even if he had 50% accuracy he would be a god amongst market mortals. A persistent 5% edge in the markets is big. Anything larger is huge . Remember, there are billion dollar casinos that make their nut on a 1-2% edge at the gaming tables. If you’re playing for a 10x, you would need to be right 10% of the time to break even. (You lose 1 dollar 9 times and on the 10th time win 9 dollars. (9*1)-(1*9)= 0 ) This means a 10% hit rate would give you a 0% edge.

Professional traders would love to get 5-10% edge on an options play over time. To achieve that level of edge you would only need a 15-20% hit rate on options going 10x. Thinking some investment guru has an accuracy rate much higher than 10% is just fooling yourself. So don’t fall for that. These far out of the money puts and calls are called “lotto options” for a reason. They seldom win, EVEN WITH high quality cutting edge analysis from the best in the world. But let’s say our guru is actually pretty good and can hit a 10x winner about 20% of the time. His marketing still lures in the suckers because it’s framed in a way that makes you dream about 10x’ing your account on one trade. This is a huge trap newer traders fall for. The only way to 10x a trading account in one option trade is to go all in. Even a novice student of risk would tell you to never do that.

There is a 100% chance of eventually going broke with that method. I (Tyler) play a lot of Texas Hold’em ring games when the markets are closed. (Got to feed the risk addiction somehow.) The stakes are fairly friendly. Most people buy in with five hundred bucks. Some sit down with a grand. The people that come to play aren’t students of the game like myself. They consistently lose. But it’s okay because they’re content with “paying” for the entertainment. They’re there for the free food, table talk, and massages from the game girls. If you have any sense of probability or riskreward, you can consistently extract money from this pool of players. It’s a fun way to earn a side income. (The cross-training between trading and poker is also incredible, but that’s a topic for another day.

) Anyway, the same guys who come to the poker tables every night to blow off steam are also the ones going all in on options plays. To them, trading is just another outlet for gambling. I can’t tell you how many stories I’ve heard at the poker table of guys who’ve taken their $20,000 trading account to $100,000 in a year and then wind up broke. They lose it all. Every single penny. But this never surprises me. Over leveraging and going all in might make for a good story at the poker table in the short term, but it always ends badly. You can’t fight the probabilities no matter how hard you try. If you plow all your money into one trade, you will go broke . If it doesn’t happen this trade, it’ll happen the next one. It’s important to think of trading as a long-term process rather than a single hot tip. True wealth is made by long term compounding, not a one off gain from some option trade.

So when the marketing gurus tout 1000% returns, keep in mind that it’s just a one off trade that you can’t put your whole account into anyway. At Macro Ops we’ll usually bet .5% – 2.5% of our account on any one trade. A lot of hedge funds will even bet as low as .10% per trade. If you follow sound position sizing mechanics and put 1% of your account into the guru’s pick and get your 10x, your total account would be up 10%. Now don’t get me wrong, that’s a great return since you only took 1% risk to get it. But it’s a far cry from a 10x on the whole wad. Misconception #2: Options Are MoreLess Risky Than Stocks. The financial media will tell you that options are more risky than plain vanilla stocks. This is true if we define risk as the volatility of returns. But practitioners will tell you that volatility is a crappy measure of risk. Other market participants will tell you the opposite. They claim options are far less risky than stocks because your loss is defined. This sounds good on paper, but in practice it’s not too important in an overall risk management system. Both these viewpoints on option risk are wrong.

Options are neither more or less risky than stocks. Risk is a function of position sizing, not product type. Let’s break it down. As an investor or trader you always want to think of your downside in relation to your account size. Say you want to buy a call option because you think the price of a stock will go up. You have a $100,000 account. There’s a chance that call option expires worthless and 100% of your invested capital is lost. But you get to choose what that 100% loss means in relation to your account. If the call costs $1.00 you could bet your whole account and buy 1000 of them. In that case if the option expired worthless, you’d be broke, having lost the 100 grand. Now say you bought only 1 call option for a total of $100 and the option expired worthless. A loss of $100 on a $100,000 account is only a 0.10% loss in total. So you see the option is not inherently more or less risky than the underlying stock.

It just behaves differently. Rather, what makes it risky is the number of calls you buy. This same argument is also used against sellers of options. Critics say “well if you sell a naked put you have limited upside and unlimited downside. That’s a very risky position.” Again, the short put is not risky in and of itself. It’s risk depends on how many you sell. For example, say you had the choice between buying shares of SPY the S&P 500 ETF or selling a put on the ETF. Let’s say the stock is trading at $206.44 and a 206 put is selling for $4.45. If you bought 100 shares of the stock, you would spend a total of $20,644. Now imagine the market got knee capped and SPY sold off 50%. You would be sitting on a $10,322 loss.

On the other hand, if you sold one of those puts struck at 206, with the same 50% decline in the market, things would play out differently. After the 50% drawdown SPY would be trading for $103.22. The puts are in the money and you owe the buyer (206 – 103.22) * 100 or $10,278. But don’t forget, you also received that original $445 credit at the time of sale. So the net loss would only be (10,278 – 445) or $9,833. You actually lost less than if you had just bought the plain vanilla stock! In this scenario selling one put option was less risky than buying plain vanilla stock. Now say you were feeling greedy and sold two puts instead of one to collect $890 in credit. And imagine the 50% decline still occurred. Instead of a $10,278 loss, you would have to cover a $20,556 loss. Subtract the credit of $890 and you’re left with a net loss of $19,666. This is MUCH larger than the $10,322 loss on the 100 shares of plain vanilla stock. See the difference? The riskiness of the put has to do with position sizing, not the nature of the instrument.

False beliefs regarding risk can be very limiting to your development as a trader or investor. Remember: position size determines risk… NOT product type. Now that we’ve cleared up some incorrect assumptions associated with options, let’s discuss the downsides to options no one ever mentions. The reason no one talks about these pitfalls is that it’s against the system’s best interest. The system wants retail traders churning their accounts at brokerages with tons of options trades. The more trades the better. Brokers earn fat commission fees and their affiliates that market for them get a nice cut too. Market making firms make a killing from the large retail order flow. And programs like CNBC can garner audience engagement by fascinating the public with their “sophisticated” options trades. But understanding these pitfalls are key to ensure your success in the options market. Pitfall #1: False Confidence And The Folly of Sophistication. False confidence in anything is dangerous. This is especially true in options trading.

It’s a silent killer that leaves its victims demoralized and broke, slamming drinks at the local bar, wondering where it all went wrong… So how does false confidence infect an option trader’s mind? It starts when an investor first learns about the plethora of option spread trades available to him. These spreads have a bunch of cute and fancy names, making them all the more interesting at first glance. You’ve probably heard of some of them: Put spreads Call spreads Vertical spreads Iron Condors Condors Butterflies Iron Butterflies Straddles Strangles Calendar Spreads Ratio Spreads Back Spreads Covered Calls Diagonals Double Diagonals Combos Collars. And the list goes on… The option “gurus” tend to whip up new ones year after year too, just to hold the interest of unsuspecting investors and traders. Now we’re not going to go into the nitty gritty of what each of these are. Most of them are bullshit and don’t matter unless you’re an options market maker anyway. But that doesn’t stop average retail traders from getting sucked in. When they first start, they get excited about figuring out what these different spread trades are. And after they can finally recite them from memory, they start to think they know something. This is where the danger begins. These spreads are very complex. Just knowing what they are is not enough to successfully use them. But novice traders don’t realize this.

Instead, they mistake their basic understanding of options spreads as skill and start to fire off trades like mad men. I know this because I did the same in the very beginning of my options trading career. Sophistication and complexity do not imply an edge. In trading the opposite is usually true. A simple process is more likely to have persistent edge than a complex process. Don’t confuse the fancy structure of these option spreads with an actual edge in the markets. Just because something is complicated, doesn’t mean it will make you more money. In fact, you may wind up losing your shirt instead… Why are all those spread structures that we mentioned above mostly worthless to retail traders? Because all they do is run up commissions and add next to no value.

The primary goal of a spread is to hedge or reduce your exposure. You’re not really trying to add anything new to your book with this method. But novice traders don’t understand this. They try to place bets with spreads anyway. And of course the brokers never mention this — they’re too busy getting rich off the fees. Take the bull call spread for example. The bull call spread is constructed by purchasing one call and then simultaneously selling another call at a higher strike. Buying the first call gives you exposure to the underlying price going up. But selling the second call gives exposure to the underlying price going down. These two positions clearly contradict themselves if you’re trying to bet on direction. Consider a 208210 call spread in SPY.

The 208 call is trading for $3.25 and the 210 call is trading for $2.18. You can buy the 208 call and sell the 210 call for a net debit of (3.25 – 2.18) or $1.07. The maximum total value this spread can reach is $2.00. (Width between the strikes of 210 and 208.) The maximum amount of profit you can make on this trade is ($2.00 – $1.07) * 100 or $93. The max you can lose is $107, or the cost of the spread. Since a vertical spread consists of two options, you have to purchase two contracts to complete the trade. Using a standard commission rate of $1.00 per contract would cost you $2.00 in total. Spending $2 in fees to make $93 is terrible. This may be hard to see at first. But add in a realistic win rate on this trade of 60% and it becomes clear. The win rate can be used to calculate the breakeven rate which comes out to 53.5%. So we’re giving ourselves a hefty 6.5% edge (60 – 53.5). If this trade played out 10 times with that 6.5% edge, it would look something like this: Total Profits: $558. Total Losses: $428. Gross Profits: $130. Commissions: $20 (2 dollars a trade times 10 trades) Net Profits: $110. Commissions cut over 15% from your bottom line!

And that’s with a cheap commission structure, strong edge, and an assumption that you let the spread expire. If you exit the trade before expiration, that will rack up another 2 dollars per trade, bringing total commission costs to $40. That only leaves a net profit of $90 — an over 30% reduction to your bottom line! You can see how these commissions add up. A cost structure this high will send even a highly skilled trader to the poor house. The economics get even worse as you tighten the option spread (use strikes closer together) or add in even more legs (a leg refers to one part of a spread). Some option spreads require 4 legs to execute! You can spend far less in commissions on a futures contract or outright stock trade for much larger upside. Another important “hidden” risk to understand about options is that they’re derivatives and therefore a zero-sum game. (Negative sum when commissions and the bid ask spread are included.) This means that whenever you take a position, someone else is taking the other side. That other person could be a retail trader, bank, commercial hedger, market maker, HFT firm, or professional proprietary trader. If you win, that other person loses. And if you lose, that other person wins. It’s a constant battle of wits between market participants. And of course the middlemen take their cut along with Uncle Sam after it’s all said and done.

With stocks and bonds the story is a little different. It’s not necessarily a zero-sum game. The pie can theoretically grow so every investor wins. When you’re invested in a company, you’re entitled to a portion of its assets and a portion of its income through dividends. All holders of the company’s stock win if it sells more widgets and earnings grow. You can theoretically get paid higher dividends while the assets you hold become more valuable. Look at the Dow since the early 1900s. Everyone was a winner as long as they held stocks long enough. The same thing is true for long term holders of sovereign bonds. An investor gives his money to the government and over the course of 10 years or so he receives his original investment and then some. The government wins from the financing it receives. And the investor wins because his cash earned some extra income.

So before you fire off that next option trade, remember: it’s you against them. Someone will lose. And you’re usually playing against a professional operator who relies on making profitable option trades to feed his family. When framed in this context, the amount of trades I took in the options market plummeted. It’s a matter not to be taken lightly. Hopefully this discussion has cleared up a lot of the false advertising and BS claims out there. With this basic understanding of the misconceptions and pitfalls of options trading, you’re ready to move to the next step — understanding and trading option volatility. We created a special report covering this very topic. You can check it out here . You might also like. “Now say you were feeling greedy and sold two puts instead of one to collect $890 in credit. And imagine the 50% decline still occurred. Instead of a $10,278 loss, you would have to cover a $20,556 loss.

Subtract the credit of $890 and you’re left with a net loss of $19,666. This is MUCH larger than the $10,322 loss on the 100 shares of plain vanilla stock.” You started comparing apples to apples in the first example of 1 Put and 100 shares. Then you changed the argument by comparing 2 Puts to 100 shares, which no longer is comparing apples to apples. It seems to me that in the second example the author would like to highlight the position size. Independently Administered Segregated Client Accounts. STP-Straight Thru Processing. And More. The Future Currency. We want to give you S$10! Sign up now and start shopping at HonestBee. Earn up to Ђ100 for each friend you invite to Skrill. Luke 6:38 - give, and it shall be given unto you. Can a Christian T rade Forex?

Someone argued that in Forex trading, one can only win at the expense of another and hence, it is no difference from gambling and it is unproductive and wrong to do so. Lets begin with the statement of "one can only win at the expense of another" Would you not apply for a job knowing that if you succeed, other applicants will not? In any competition, there will be winners and there will be losers. Moreover, in trading (not gambling), losers lose, not because another trader took from them and winners win, not because they took from a losing trader. A "trade" is a business transaction, where the buyer and the seller agree on the value of something exchanged, be it currencies, stocks, bonds, futures contracts, cars or houses etc. There is no disagreement between the buyer and the seller and there is nothing unethical about trading. The fact is that the buying and selling of currencies is no difference from the trading of goods which we try to buy at a lower price and sell them off at a higher price to make a profit. . you make profit a dirty word, Singapore dies. - The Late Mr Lee Kuan Yew, Founding Father of Modern Singapore. What about " it is no difference from gambling and it is unproductive and wrong to do so ". The difference between the Casino and the Forex market is that, most are games of chance in the Casino while it is about economy and a contest of method for the Forex market . Unlike the gambler who has no control of the process and outcome of the game of chance , the trader can rely on price patterns , fundamental and technical analysis to decide on the opening and closing of a position with a probability of winning in hisher favor. Another good way to differentiate trading from gambling is this: Imagine playing a game like blackjack and not having to put any money on the table until I have seen the dealer's cards, and then being able to risk as much or as little or even not at all.

Furthermore, if I do decide to proceed, I can change my mind and withdraw my money off the table as long as the opening price that I set for buying or selling (stop or limit order) is not met - THAT'S TRADING! In addition, I have the ability as a trader to increase my profits (let my profits run) whenever the odds are stacked in my favor and mitigate my losses (cut my losses short) when my decisions are wrong. Hence, a prudent trader is more like an astute businessman or for that matter anyone who has the seriousness to make and control buyingselling decisions. All of us have to take some calculated risks in our transactions in order to achieve the potential rewards that we envisaged. Forex trading is an essential economic activity. The Forex market facilitates the proper functioning of global trades and market participants including spot traders contribute to the liquidity for the exchanges of currencies. International business transactions where currencies are required to be swapped will not be possible without the existence of an active FOReign EXchange market. While Forex trading is a zero sum game where the total gains must equal all the losses, it is also subjective because there are instances where a trader's gain need not arise from the loss of another trader. For example T rader I b ought from Trader U , Singapore dollars and sold the S$ later for a profit after the S$ has appreciated in value. Similarly, Trader U could also profit from the exchange had he bought the S$ at a lower price before he sold it to Trader I f or a profit. Is it wrong to trade? A stricter interpretation of t he Holy Bible's 8th. Commandment " You shall not steal " should include activities that cheat or harm to enrich oneself.

Like any other legitimate businesses or professions whose goals are to make a profit for ourselves, trading is definitely not dishonest as we are not out to swindle others and not harmful if we don't treat it like gambling. It is also unreasonable to approve the trading for profit of traditional goods and services but disapprove the trading of currencies, stocks and properties etc. In the Parable of the Talents ( Matthew 25:14-30 Luke 19:12-28 ), we are to make good use of our God given abilitiesmoney to achieve a positive return on our investment of time and resources . Failing to do so will incur God's wrath. Automation increases our productivity and frees up time for us to do things that matter more to us than just hard work! Due to its low cost of entry as compared to traditional businesses which require high capital and on-going expenditures, t he spot Forex market offers a viable option to the retrenchedretired to learn a valuable skill and make better use of their money to work for them instead of them working for the money. Some of us who are astute in Forex trading can also choose it as a respectable profession to make a sustainable living out of this $ 5 trillion a day economic activity. In short, trading is a viable way to grow our wealth. Its goal is similar to investing in properties, stocks etc. or entrusting our money in the hands of fund managers to make better use of our spare cash. Does financial trading serve any useful purpose, or are traders just parasites? In conclusion, there is nothing wrong with Forex trading if we treat the Forex market like any other market places where opportunities can be seized and risks can be mitigated . What gives Forex trading a bad connotation is when people treat the Forex market as a casino.

It's also my hope and prayer that through my trading and programming skills, I can be a blessing to others. FXPRIMUS wins award for Most Trusted Broker at MENA 2015 Forex Expo, Dubai. Why just trade when you can also earn residual income and rebates for your trading? Increasing number of Individuals, Corporate Traders, Money Managers and Website Owners have already opted to become our traders and our partners in this $5 trillion daily turnover Forex market. As an individual retail trader at FXPRIMUS, you experience a level of fund safety, trade execution and service quality that is normally reserved only for large, institutional investors. We welcome you to now to enjoy the same advantages as the institutional trader s and expand your income potential while offering your referred clients one of the highest available level of service and support. Please ascertain your eligibility in your application and that the Referral ID is 374 during your signup. Thank you. Automate your Profitable Trading for FREE? Would you like to trade with your very own EA? We have helped several of our traders to become more productive by automating their profitable trading rules for FREE. Free Video Training and Tutorials. Simply open a free Practice account or Live account and get free access to more than 40 video tutorials for beginners and advanced traders.

and it would be our pleasure to share knowledge and tips on trading and automation with you . We are successful only if we can help you to succeed in your trading. Unlock the business potentials of online trading today! Make money with your own or rental car. Sign up now and start shopping at HonestBee. Luke 6:38 - give, and it shall be given until you.