The Statistical Truth
I hate to say this about some of my fellow options traders, but I can't tell you how much I abhor those in the industry (you know who you are) that absolutely ruin the true benefits of options for the self-directed investor. Claims of outlandish 300%, 400%, 1200% in just a few days. Encouraging the use of low-probability out-of-the-money puts as a predominant strategy without the mention of selling premium.
It's frustrating. It's frustrating to see so many so-called gurus with no real-world experience act as options traders when their services fail time and time again. Again frustrating.
For some reason investors don't crave what's truly important, realistic strategies with realistic gains. Transparency. Knowing that trading isn't easy and is a life-long endeavor and that while the journey may be bumpy at times over the long haul it is worth all of the effort. A long-term approach to short-intermediate-term trading with high-probability trades as its foundation. Selling credit at every extreme. Always talking about the importance of position-sizing. Always considering risk-management.
Why would people rather join services that tout such outlandish claims? It is beyond me. Are self-directed investors really that gullible? Why do they continue to fight statistics?
It is my hope that I have carved and will continue to carve a slice of decency and transparency into the options world. I am certainly not perfect, but I know that selling options is a valuable strategy with an overwhelming statistical advantage. And it is my goal to teach as many self-directed investors as I can about the benefits they offer.
Use Probabilities Now!
Some people will try to take a simple concept and sprinkle it with some mumbo jumbo to make it seem complicated and then claim only they can explain it to you! Don't listen or don't buy into any such load of bunk!
Take options. Yes, a lot of people, maybe even your stockbroker, will tell you options are too complicated and confusing. What they may really be telling you is options are something they don't want to spend the time to understand, so they don't want you to trade them either!
It was only ten years ago that there were only a privileged few investors who could take advantage of things like streaming quotes and real-time options chains. Options were shrouded in mystery and deemed too complex for the average Joe - to be traded only by the so-called "sophisticated" professional investors.
Since then, however, seismic changes in the options world have leveled the playing field for individual traders and investors. Thanks to advances in technology, innovative trading tools, and better access to what was once privileged information, the self-directed investor is now equipped with the ability to trade like a professional options trader.
So, now that we as self-directed investors have the same technology as professional traders why aren't we applying the technology in the same way?
We all know that a stock or ETF only has a 50/50 statistical chance of success. That's right, no better than a coin flip. But, what most self-directed investors don't know is that there is a way to increase the statistical chance of success to well above 50/50. Professional options traders do, and they have been using powerful, statistically-based strategies for years. But, as I stated before, now we have the same technology. Now it is up to us to use it to our advantage.
If I could choose one of the more powerful tools offered in today's options trading software it would be the option theoreticals offered. Probability of Expiring (ITM or OTM) is the most informative data point among the options theoretical and one that I employ every day for my readers at Crowder Options.
The Power of Probabilities
Probability of Expiring is the chance that a stock will close in-the-money at options expiration.
So, the real question is, how can you use Probability of Expiring to your advantage?
Say, I believe that the SPDR S&P 500 ETF (NYSEARCA:SPY) is currently in a short-term overbought state and the market is due for a sell-off and I want to place a trade that has roughly an 85% probability of expiring out-of-the-money, or as I like to refer it as the probability of success.
I realize that some of you do not have access to trading software that gives you the probability of success, but any worthy trading software will provide you with the delta of any given option.
Just look above and you will notice that how delta the probability of expiring out-of-the-money minus 100. The formula 100-delta = POE.
So, let's look at how we can apply probability of expiring out-of-the-money or delta to the real world.
Hypothetically speaking, I want to place a defined-risk, bearish trade with an 85% chance of expiring out of the money.
A bear call spread fits the bill.
As seen in the option chain above the 148 calls have a probability of expiring out-of-the-money of 85.48%. That means there is only a 15% chance that SPY will close above 148 at January options expiration. In other words, the trade has an 85% chance of success because you want a credit spread to expire worthless by not climbing above the 148 strike.
I could sell the 148/150 bear call spread for roughly $0.25. A return of 14.3% if the trade closed at or below $148 at January expiration.
Not bad for a trade that has an 85% probability of success.
If you choose a trade with a lower probability of success, such as 67% you will be able to bring in more premium with less capital at risk. But, it is important to realize that when you give up probability for premium your chance of success declines.
Simply stated, the greater the risk, the greater the gain. You must always take that into consideration because ... is it worth making an extra 10% to give up 20% in your probability of success? Sometimes yes, sometimes no - it truly depends on your risk profile and conviction. In my case, I always side with probabilities. I want consistent income on a monthly basis. I don't want the stress involved with lower probability trades. It just doesn't make sense in most cases.
No glitz or glam here - just straight trading.
There is no doubt that we're at a special time in history. I think we'll see statistically-based trading absolutely explode over the coming decade. Early adopters like you and I will be sitting in the driver's seat as wave after wave of novice options investors come into the fold.
Disclosure: I am short SPY, IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.