Truth #2: Options Are Priced so That They Decrease in Value More Often Than They Rise
Truth #3: Option Market Makers Price the Option to Win 70% of the Time
These two truths are closely related so we’ve combined them into one discussion. The truth is options are not like stock. A stock buyer can hold the stock forever. Options traders don’t have that luxury. Stock buyers can set stop losses and profit targets to give them a mathematically proven statistical base winning percentage. Options traders don’t have that luxury. The initial price of an option is set by (and in favor of) the market maker and the reality that time value decays and the option will eventually expire present real danger to option traders.
But, options also present such an exciting and potentially lucrative range of possibilities for profit that every investor and trader should make implementing them a priority. Any percentage move in the stock creates a much bigger percentage move in the option. Option buyers put less money into the trade (risk less) and have the potential to make a large multiple on any move in the underlying makes in the desired direction.
Additionally, options give people strategies to take advantage of every kind of market. There are cash flow strategies, market neutral strategies, protection strategies and speculation strategies. Each of these strategies key in on the corollaries mentioned above:
Option sellers have a higher probability of winning but are guaranteed smaller profits in comparison to the risks they take on each trade.
Options buyers profit only if the underlying rises fast enough that the gain in the intrinsic value part of the option offsets the losses of time fluctuation and time decay.
Option buyers have a lower probability of winning compared to option sellers, but make much larger percentage gains when they do win.
These corollaries align well with the probability profiles discussed in lesson 1. The Win Frequently probability profile often employs option selling strategies. The Win Big probability profile often employs option buying strategies. The Just Win probability profile is flexible enough to enter trades either as a buyer or a seller. Future lessons will explore the risks and rewards option buyers and sellers both face as they implement the various strategies you’ll learn through your course of curriculum.
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