If you like to trade options, you probably like to bet on sports. I don’t know about you, but I like to bet on basketball.
When I bet on basketball I like to bet on the over/under. The over/under is the total number of points that the casinos in Vegas think the two teams will score combined.
When I bet on the ‘Over’ in a basketball game, I am betting that the two teams will score more points than the casino’s think will be scored.
When I bet on the under, I am betting the two teams will score fewer points than Vegas thinks they can score.
It’s not a huge surprise I would like playing the over/under because it’s a lot like when I would make markets on the trading floor of the CBOE. The only difference is that when I was on the floor, I was the casino, not the gambler.
I really like to bet on the over because I feel like I am in control of the game.
But more importantly I feel connected to the two teams. When the players are shooting I feel like I am shooting.
It’s no fun to root for the players to miss shots. Cheering on a slow game is just plain boring.
As my odds of winning go up and down with each shot, I am brimming with excitement. It’s like when I was trading a hot stock in the pit back on the Cboe.
When they miss, I feel it. It’s completely gut wrenching for me. It feels a lot like when a position I was carrying went bad.
And if the over/under bet is coming down to the wire, the feeling of being at the sports book, for me, is as intense as when I was deep in a stock on the floor of the Cboe.
It’s almost like: I AM IN THE GAME.
This is because I am rooting for action, not rooting for the clock to wind down.
When I buy options I am ROOTING FOR ACTION.
If I buy a call in AAPL, I don’t want Apple to be range bound. I don’t want it to sit where it stands, I want AAPL to hustle.
Part of what is fun about buying options is that I can be in the game cheering for the stock to go higher when I own calls and to go lower when I own puts.
I know, I know you are asking this: Wait…if I buy options aren’t I destined to lose?
Yes, you are, if you don’t have a reason to buy options.
In Las Vegas, gamblers that win at a much higher rate than the average gambler are called ‘Sharps.’
What separates the ‘sharps’, that bet on over/unders, from those who lose is the same thing that causes option buyers, that do not know what they are doing, to lose to the market makers.
Just like Vegas, Market Makers get it wrong sometimes:
They get it wrong WAY more often than you might think.
When I traded Best Buy on the floor of the CBOE, earnings used to be a bit of a snoozer. We priced the stock to move about 5% almost every cycle, and almost every cycle it moved about 6%.
Ahead of earnings, people started buying calls up left and right. We thought nothing of it, but low and behold, earnings blew the doors out and the stock went up close to 15%.
We all lost money on the move. We were wrong on our ‘over/under’ for Best Buy.
Do I like betting the over…yes, but only if I think I have an edge over Vegas.
Do I like to buy options? You bet! But only if I know I have an edge over the market makers.
That edge is understanding concepts of volatility. Having a grasp on volatility is what separates the winners from the losers.
So when do I buy options? When I think there is GOING TO BE ACTION and when I think the COST OF MAKING THAT BET IS WRONG.
Right now, there are all kinds of mispriced options out there. We have had options mispriced in giant names and won big. Options have been too cheap in AAPL, XOM, AMTD, IBM, and JNJ.
These are HUGELY active names, with a ton of volume and yet, the option prices have been wrong!
We have scooped in and traded options on all of these names and won. Because the market makers got it wrong.
Can you learn to do this? Yes you can. How? Stay tuned, I’ll be talking about that next time.
Your Only Option,
PS In my next post I’ll explain when the cost of making a bet might be too high, not too cheap. Until then take a look at a few names that you think will move, see if you can spot opportunities where the market makers might be wrong.
PPS: My next webinar is still THIS Wednesday at 4:30 ET on Trading around the Holidays
PPPS: I’ll be showing my Secret Santa Strategy then.