Writing about trading options

This morning I watched most of an excellent video almost two and a half hours long on options trading and in watching it a lot of things have just clicked and it is just fun to learn about different options strategies now. took up significant mental processing space but I am getting more and more fluent in the language. When you start learning about options there are probably going to be all sorts of things that do not make sense and what you learn will, if you’re sufficiently curious, generate so many more questions than answers, but eventually if you are patient and stick to it it will all come together.

At first, remembering things like the basic difference between a call and a put as far as whether a lower or higher strike price than the current market price is ‘in the money’ or ‘out of the money’, took up a large percentage of my processing space when I was learning anything else about options. When you buy calls (long as opposed to short positions) of course the more in the money strike price is going to be one that is lower than the market price: you are looking for the stock or underlying instrument to go up and if you get to exercise your option to buy it for lower than its market price that’s a good thing and though you usually don’t want to exercise your option a chance to exercise the right to buy a stock at a lower price is more valuable than the right to buy stocks at a higher price. Puts are shorts, and you want the stock to go down: you’re contracting for the right to exercise the *sale* of a stock at a certain price, the strike price, and getting to sell a stock at a higher strike price is a good thing…. though you might still buy call options that have a strike price above the market price and put options,  where the strike price is lower, for various reasons including because these out of the money options are usually a lot cheaper and you can buy several out of the money contracts for the price of one in the money contract; which gives you more chances to profit, even if some of these contracts expire worthless and out of the money. The possibility of winning bitnon a large chsnge in stock orice is greater with out of the money options.

It is so helpful to write out what I know like that, and the way I explain things is not at all the same way I would have a few weeks ago, because I know all sorts of new things and have different questions now. I realize sooo much more information goes into my thought process about these things than I even felt capable of before but now I am able to sort of articulate how the whole system of trading options works together. Options trading education feels like learning about a system like learning the psychological systems of Freud or Adler or Rank or Jung, and you kind of have to have a grasp of the logic of the whole system for any of it to make total sense. It can be kind of hard to wrap your mind around at first, at least if you are me, because there is the whole area of options strategies and things you do with options themselves and then there is a whole other field of knowledge as far as stocks and technical analysis of stocks and what will trigger your entry and exit into and from a position (i.e. what conditions need to be met for you to place a buy or sell order for an option?) That feels at least right now like a totally different body of knowledge than knowledge about options themselves like what strike price to buy at and combatting theta decay with strategies like buying when implied volatility is low to give yourself an edge (since as in many things in life, things tend to revert to the mean, and when implied volatility is below the mean, it is likely to cross that mean again before

too long, and when implied volatility goes up, this raises the price of the option premium because there is more implied interest in the stock and a more volatile stock is more likely to break across the strike price into the money, but it is also likely to make a big price change in a negative direction, too.

I guess one of the reasons options premiums are more expensive when implied volatility increases is that this volatility is a good thing if it can swing you into a much higher (or lower if you’re buying a call) stock price (whereas stocks with little volatility are unlikely to move much at all). Though if the volatility sends the stock in a bad direction, we will lose our premium, but that is *all* we will lose, whereas if the stock goes up we can stand to gain a whole lot more than our premium. The downside is much more limited than the upside as is evident when you look at options profit-loss charts: you might lose no more than $100 if the stock goes down but you might have $1000 if it goes up. Still, there is a thing that applies to many things in life, like mean reversion, and I am learning today how this implies not only to moving averages but to implied volatility. When volatility has been higher than the mean for long enough it will likely revert back to that mean. Options have more extrinsic value and higher premiums when implied volatility is high, so when it drops, as it inevitably will, premium goes down. Therefore, *enter* trades when implied volatility is low, and *exit* when implied volatility is high, because that is also a great way to reduce the impact of theta decay (how an option premium’s value decays over time, which is another really important thing you need to have some kind of grasp of to trade options, and it is amazing to winder how many out there are trading options without even the basic training on how to turn the steering wheel? There are a lot, apparently, and they all have to have $0 in their accounts, because I can’t imagine anyone who bought options without understanding basic facts and concepts could be half as successful as they would be if they put chips down randomly on the roulette table!

And yet if you know how to strategize and understand your rationale for trading in precisely the way you trade, you can give yourself edges that would seem to give you so many more ways of ensuring your own success by playing your own way than a roulette table ever could. It can be so much fun, at least so far, and one of the things I like about the actual trading of options is that it is literally trading contracts with another human being, which is for me sooo much different theoretically and conceptually than buying direct shares in a company from another party. I love that with options it is always a contract. It is a friendly deal with another human being somewhere in the workd who has learned the language of options trading just like you and has decided to make a bet. It feels a bit like a game of chess, in that way, with perhaps even more ways of quantifying that you are a grand master.

We can implement strategies for buying options that give us an edge as far as success rate (delta is a really cool concept in options for a lot of reasons including one that most traders apparently don’t know about which is that it tells you the approximate likelihood of an option contract expiring in the money or of you being profitable. I do not know *how* delta tells you this though and I don’t know what the evidence is that it is true: have people done studies like, watch a bunch of contracts with a delta of 20 or 20% chance of profiting and see if indeed one out of five of them pans out? If delta can be counted on to be that kind of predictor it seems that can be huge as you can weigh your profit loss potentials for a trade (low risk, high reward?) with your probability of success from delta and give yourself an edge in all sorts of ways. If you have a high chance of profiting and it is a low risk, high reward trade, the the odds are ever in your favour!

So I am exploring all sorts of strategies and different ways that people look at options and it is such a fun strategy game, really. I feel most at home doing it when I think of it that way while also remembering this is real money or can be should I choose to buy actual options contracts. There are so many different strategies for different risk levels, account sizes, and all sorts of things, and it is fun to play with all the data and variables and strategizing and game theorising at least when I am not afraid of messing it up and taking steps ahead of my education is one way I could mess it up so I am taking it slow and learning a lot and somehow though it is absurd because each of them must have $0 there are supposedly a lot of people with even less options knowledge than me who go on trading them on the off chance that an off shot in the dark will hit the bullseye! And it won’t, it can’t… I know enough about options to know how true that is, that without the proper knowledge you are destined to lose your account. It is a process of figuring out what that proper knowledge is and at what point I myself feel sufficiently satisfied that I know enough myself that I am unlikely to mess it up with something silly? There are so many foolish things other people must do who have less knowledge than myself because I have basically averted so many of these foolish things already with the knowledge that I do have. The question is, what knowledge do I need now to avert the mistakes that a future self would tell me I could have averted with a little bit of knowledge? What do I need to satisfy myself that I am ready to trade options (or enter or exit from a particular trade)?

So when you profit from options you are making money, not from a company, despite there being an underlying stock involved, but from a bet you make, hopefully with good reason, with a hopefully rational person on the other side of the exchange. You are making an agreement with another person and making money if your bet on this so important contract that you somehow do not have to physically sign for, is right.