lystn

Hey everyone, welcome back and this is Kirk here again on the daily call. Today’s daily call, I want to talk about this concept of unlimited profit potential which is really a code for low probability of success. I really love this concept. I think if you understand this concept that I think a lot of people when they get introduced to trading or introduced to investing, they really understand this concept. They understand why a lot of people lose money. A lot of people lose money in investing or it doesn’t have to be necessarily options trading, but just investing in anything. I think lottery tickets in this case is like the classic example where there’s this huge upside potential, but a very, very low probability of success. People get sucked into this because they think about the upside potential, but they never factor in or they never look at the expectation of actually generating that money. Like what is the probability that I make that money? People pay in the case… The classic example of this obviously is a lottery ticket where people for years will pay $2 or $3 a week. I mean, my wife was like totally guilty of this and I’ve thankfully stopped her from doing this, but she loved to do these scratch off tickets. It seem like every time she went to get gas when we were first dating and she was in college, she would get like $5 worth of scratch off tickets. For her, it was just like she liked doing the scratch off and she would win $20 and that would pay it back. But I mean, like long-term, you’re going to lose money at those and that’s what I kept trying to tell her is like “You’re literally losing money.” I said, “$5 every other day basically for the rest of your life, that’s a lot of money that you could be saving.” People don’t think in those terms. Maybe I’m just weird and I think in those terms. But this idea of unlimited profit potential always carries a low probability of success. Look. If there was always unlimited profit potential and high probability of success, you'd see millions of people who are millionaires overnight by doing basically no work and that's not possible. You can’t have that in most capital markets, especially in capital markets that are as efficient as the ones in the US. Most of the developed world has very efficient capital markets. You can’t have unlimited profit potential with a high probability of success. It doesn't happen together. Another great example of this and probably a premiere example of this is Warren Buffett. If you really look at Warren Buffett's portfolio and what he invested, he has mainly invested most of his wealth and most of Berkshire Hathaway's investments in insurance companies. Now, think about what an insurance company does. Insurance companies are basically just an option seller. They sell insurance contracts where they take in a defined amount of money which basically caps their income potential on any specific asset for a year or two years or whatever the case is, but they have high risk that they might have to facilitate the buyback of that asset or the rebuilding of that asset. Think about your house. You could buy insurance on your house from an insurance company. You pay them $400 a year, so the insurance company never makes more than $400. But if the house burns down, the insurance company has to come in and rebuild the house, $200,000, $300,000. But with capped profit potential in this case, you have extremely high probability of success. And so, what you get yourself into is this self-fulfilling cycle of generating consistent, reliable income as long as you keep position size in check. I think that’s what you see with most insurance companies. In fact, read Berkshire’s 10 Ks and 10 Qs. We’ve talked about this on other podcast. Buffett talks about this concept of capping potential profit in exchange for high probability of success to generate cash flow. That's really why he does it. That’s why he loves the insurance business. If he was taking the other side of the coin and if he was trying to make money on houses burning down which is basically what most people are doing in the options market or buying lottery tickets or trying to make money on random events that just don't happen that often, he’d be buying insurance on all of these houses for people assuming that they would burn down and he’d have a big payout. That’s taking the other side of the trade. That’s what people do in the options market. People in the options market buy these contracts either out of the money or not. They buy these contracts all the time assuming this huge payoff and maybe once or twice, they might hit a nice little payoff and that creates a cycle of this false sense of security or false sense of success and they continue to buy contracts and continue to buy contracts, knowing that over time, they’re just generally going to lose money. Again, it’s like my wife buying these lottery tickets when we were first dating in these scratch offs, like she would pay $5 and then she’d win $25. I mean, that’s a 5x payout and that would fulfill her need to then trade or buy scratch off tickets the next five times because “Hey, I’m up money.” But over time, you're going to lose money in those types of investments. It's just a matter of time. That’s why this concept of unlimited profit potential that I see everywhere is so bogus because it carries a very low probability of success. Again, I guess the key takeaway here today is just ask yourself with any investment. It doesn’t have to be options or not. But ask yourself with any investment, like “What’s the probability that I actually generate money or generate X money on this or generate X growth on this? Is there a good probability of success, low probability of success? What are the underlying fundamentals of it that could change how I make a trade in this or how I invest in this?” Hopefully that helps out. As always, if you guys have any questions or comments, let me know. Until next time, happy trading!