lystn

Hey everyone. Welcome back to the daily call. On today’s daily call, we’re going to talk about a classic options trading mistake that maybe a lot of newbie’s fall prey to and it’s called – “When you’re right, but still lose.” This actually reminds me of like when I was a kid with my sister. I only have one sister. I love her to death, but we used to fight a lot as kids obviously. All the time when we were fighting, if I was doing something or she was doing something and we got into an argument, my parents would come up and they would basically reprimand us both and they would say, “You’re both wrong. Go to your room.” It would drive me crazy, honestly. Like still to this day, it drives me insane because most of the time, I was probably right. They just send us both to our rooms because we’re still fighting, so we would still both lose even though maybe I was right. Maybe she was doing something wrong or maybe I was doing something wrong. Who knows? But most of the time, I was probably right. Anyways, the reality though is that it can be really hard when you’re trading and you get things like direction right. This is a classic trading mistake that I think a lot of people make when they start out, is they think that options trading is one-dimensional because the reality is that stock trading is one-dimensional. In fact, most investing is one-dimensional. I think probably real estate is probably another good analogy for something that’s multidimensional investing, meaning you generate cash flow in different avenues. Like real estate, it's the cash flow in the property, it’s the appreciation of the property, the appreciation in taxes, etcetera, tax write-offs. But in stocks trading and futures trading, Forex trading, penny stock trading, day trading, etcetera, it’s all one-dimensional, meaning that you only generate money by buying securities and selling them at a higher price or selling securities and buying them back in a lower price. One-dimensional. You can only make money one way in that directional movement. When people get started trading, they think that that's the same thing with the options market. But the options market is multi-dimensional and in fact, the dimensions are much more important when you factor in things like time decay and volatility decay or just the impact of volatility and time decay on the option contract. It’s no longer just if the stock moves in my direction that I make money. It’s also how far did the stock move in my direction and how much time did it take, what happened with volatility. We’ve often seen a lot of examples and probably earnings trades are the classic example of this where a stock makes a huge move, but the volatility collapse that happens right after an earnings event decays the premium down. That overshadows any move that the stock might have made. The stock might have made a 5% move or a 10% move in a single instant, but that move was either expected or was expected to do more than that and so, volatility drops and the option contract values drop. We actually recently did a podcast on this on the regular weekly show that we have at Option Alpha where we talked about these expected moves through back-testing that we've seen and we know that these expected moves, they’re always too great than what actually happens, meaning the market always over-expects a stock to move in one direction or another and the stock never moves as much as people expect it to move. This is a great example of how you can be right in expecting a big move or a big directional move, but still lose in your option contract. The key takeaway really on today’s daily call (because I see this a lot and this is why I wanted to get this podcast out today) is just to understand the other facets of how you can generate money or not with option contracts, just like what are the levers that you can push or that the market pushes that enable a contract to go up or down in value. Again, it’s not just the directional move in the stock. It has time decay implications, Gamma implications as you get closer to expiration, volatility implications, etcetera. You have to understand those components and it’s not a bunch of… You don’t have to do a dissertation on it to understand it. They’re pretty easy to understand once you get into the education a little bit. We’ve got obviously education and free training on Option Alpha that helps guide you through this. Again, it’s really important that you understand just those components of an option contract. Hopefully this helps out today. As always, if you guys have any questions or comments, let me know in the comment section. Until next time, happy trading!