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Options are effectively Zero Sum - meaning that whoever is on the other side of the contract is predicting the opposite of whatever you're thinking. Successful

Options are effectively Zero Sum - meaning that whoever is on the other side of the contract is predicting the opposite of whatever you're thinking. Successful long-term options traders don't trade options 'directionally' (like buying 50K of GME calls), they manage a whole portfolio of options, and then take directional portfolio risk. This is sort of like diversifying, then running risk analysis, then figuring out where there is money to be made ie dummies who priced contracts incorrectly. And, to run an option portfolio, professional options traders run risk management software like Blackrock Aladdin and Goldman Sachs SecDB. These cost a LOT of money (close to 6 digits a year) Now, remember the zero sum part? No matter how smart you think you are, if you don't have these tools, you don't have the data or analysis that is available to the big boys. It's like playing poker with someone where they know the exact odds every second as cards appear, but you only have the vaguest idea.. Sure, you could get lucky once in a while but in the long run, not knowing the odds is going to hurt you and you are likely to lose all your money.

ramraj07 6y ago
But the truth is all the awesome analyses with those programs still cannot actually predict the STOCK PRICE right? If I truly believe I have a better guess about whether a stock is going to go up than the general market conensus (which is what I'm assuming is powering options pricing), then I do stand a chance of making money right? None of what you say seems to change anything about how a regular investor looks at an option as - it's just a magnifying glass on how much you can make or loose by betting on a stock. Either you get lucky or you are actually insightful in some stocks, that's the edge you have (if any) over the career traders who don't want to rely on this luck to make their money.
- deleted 6y ago
  [deleted]
- JumpCrisscross 6y ago
  > If I truly believe I have a better guess about whether a stock is going to go up than the general market conensus (which is what I'm assuming is powering options pricing), then I do stand a chance of making money right? Yes [1]. But a one-way single-leg options bet is far less likely to make you money, in that case, than just going long or short the stock. [1] I am going to parse “truly believe” as have an information edge, i.e. you have seen something nobody else has acted on. Which happens surprisingly often to individual investors.
  - scythe 6y ago
    > far less likely to make you money, in that case, than just going long or short the stock. Yes, but puts are a lot safer than shorts, because the downside is finite.
  - ramraj07 6y ago
    Makes sense. My limited understanding is that with options I don't just have to guess that the stock will go up but also by how much and when. Agreed that many amateurs (like me) don't realize this well enough.
    - JumpCrisscross 6y ago
      > My limited understanding is that with options I don't just have to guess that the stock will go up but also by how much and when Also interest rates, the stock borrow rate, dividends, the shape of the volatility curve, et cetera.
- bob33212 6y ago
  It depends on the situation. For example, if you believe that the FDA approval for Moderna vaccine will be revoked next month, using an option could be a good way to make money on what would obviously be very bad for the stock next month. On the other hand if you just generally like company you could buy that stock directly and not worry about finding a 3rd party to take the other side of the bet. That 3rd party is trying to make a profit and even though you may be right and that 3rd party may be wrong you are still introducing a 3rd party into the investment.
- frgtpsswrdlame 6y ago
  >If I truly believe I have a better guess about whether a stock is going to go up than the general market consensus then I do stand a chance of making money right? Yes but options aren't just about direction, they're about timing too. The thing about holding a stock is you only have to be right about one thing but with options you have to be right about two.
ROARosen 6y ago
That is not completely true, options a by-and-large used for hedging purposes to mitigate losses in the event something goes wrong with your principal. Of course, there will also be long plays in options, but that is not the majority. This is evident from the fact that there is generally higher implied volatility for puts rather than calls, which implies more contracts on the put side than on the call side. That would not be the case in any other zero-sum investment - say, forex. Also generally the stock market is by nature a long market so the options market should have been long-heavy. The reason for this is because the options market is saturated with huge portfolio holders are using it merely to hedge against their long investments.
caffeine 6y ago
Sorry but this comment is full of misinformation. > whoever is on the other side of the contract is predicting the opposite of whatever you're thinking. If you are a retail options trader, the person on the other side is a professional market maker who doesn't have a "prediction" the way you'd think about it. He made his money at the moment you did the trade, because you traded at a disadvantage relative to the fair value of the product. > And, to run an option portfolio, professional options traders run risk management software like Blackrock Aladdin and Goldman Sachs SecDB. These cost a LOT of money (close to 6 digits a year) No, options desks run (usually proprietary) models whose job it is to price options and strategies along the curve in a self-consistent way (i.e. via no-arbitrage arguments) relative to some more liquid instrument like futures. OR on a bank exotics desk, they run custom models that try to price exotic products from first principles (monte-carlo simulations of cash flows, basically.) > (close to 6 digits a year) Way more expensive than this, the quants and developers who build these proprietary models are paid a lot of money. > Sure, you could get lucky once in a while but in the long run, not knowing the odds is going to hurt you and you are likely to lose all your money. This is both accurate and not, it depends what you are doing. I believe sophisticated retail traders can find mispricings, especially in less liquid products. If you are not looking at the vols and building curves, (or you don't know what that means), this is not you.
- nealdotpy 6y ago
  Glad someone rebutted. I'd like to add the person on the other side of a retail long options trade can be a market marker or people like me that sell to retail for the same reason. :)
- scsilver 6y ago
  What are vols and building curves? The factors that effect extrinsic values? Volitilty and time?
  - caffeine 6y ago
    "Building a curve" means defining a function of where you think volatility should be as a function of strike and expiration. https://www.investopedia.com/articles/stock-analysis/081916/volatility-surface-explained.asp https://www.investopedia.com/articles/stock-analysis/081916/... It gets substantially more complicated, but that's a layman's explanation of what it actually is.
newleaf 6y ago
Just to add to your point which covers speculation, options can also serve as an insurance policy (hedge). Have a large exposure to the stock market and are not looking to sell? Buy puts and receive a payout if the market drops (simplified explanation, of course).

ramraj07 6y ago

But the truth is all the awesome analyses with those programs still cannot actually predict the STOCK PRICE right? If I truly believe I have a better guess about whether a stock is going to go up than the general market conensus (which is what I'm assuming is powering options pricing), then I do stand a chance of making money right? None of what you say seems to change anything about how a regular investor looks at an option as - it's just a magnifying glass on how much you can make or loose by betting on a stock. Either you get lucky or you are actually insightful in some stocks, that's the edge you have (if any) over the career traders who don't want to rely on this luck to make their money.

deleted 6y ago
[deleted]
JumpCrisscross 6y ago
> If I truly believe I have a better guess about whether a stock is going to go up than the general market conensus (which is what I'm assuming is powering options pricing), then I do stand a chance of making money right? Yes [1]. But a one-way single-leg options bet is far less likely to make you money, in that case, than just going long or short the stock. [1] I am going to parse “truly believe” as have an information edge, i.e. you have seen something nobody else has acted on. Which happens surprisingly often to individual investors.
- scythe 6y ago
  > far less likely to make you money, in that case, than just going long or short the stock. Yes, but puts are a lot safer than shorts, because the downside is finite.
- ramraj07 6y ago
  Makes sense. My limited understanding is that with options I don't just have to guess that the stock will go up but also by how much and when. Agreed that many amateurs (like me) don't realize this well enough.
  - JumpCrisscross 6y ago
    > My limited understanding is that with options I don't just have to guess that the stock will go up but also by how much and when Also interest rates, the stock borrow rate, dividends, the shape of the volatility curve, et cetera.
bob33212 6y ago
It depends on the situation. For example, if you believe that the FDA approval for Moderna vaccine will be revoked next month, using an option could be a good way to make money on what would obviously be very bad for the stock next month. On the other hand if you just generally like company you could buy that stock directly and not worry about finding a 3rd party to take the other side of the bet. That 3rd party is trying to make a profit and even though you may be right and that 3rd party may be wrong you are still introducing a 3rd party into the investment.
frgtpsswrdlame 6y ago
>If I truly believe I have a better guess about whether a stock is going to go up than the general market consensus then I do stand a chance of making money right? Yes but options aren't just about direction, they're about timing too. The thing about holding a stock is you only have to be right about one thing but with options you have to be right about two.

ROARosen 6y ago

That is not completely true, options a by-and-large used for hedging purposes to mitigate losses in the event something goes wrong with your principal. Of course, there will also be long plays in options, but that is not the majority. This is evident from the fact that there is generally higher implied volatility for puts rather than calls, which implies more contracts on the put side than on the call side. That would not be the case in any other zero-sum investment - say, forex. Also generally the stock market is by nature a long market so the options market should have been long-heavy. The reason for this is because the options market is saturated with huge portfolio holders are using it merely to hedge against their long investments.

caffeine 6y ago

Sorry but this comment is full of misinformation. > whoever is on the other side of the contract is predicting the opposite of whatever you're thinking. If you are a retail options trader, the person on the other side is a professional market maker who doesn't have a "prediction" the way you'd think about it. He made his money at the moment you did the trade, because you traded at a disadvantage relative to the fair value of the product. > And, to run an option portfolio, professional options traders run risk management software like Blackrock Aladdin and Goldman Sachs SecDB. These cost a LOT of money (close to 6 digits a year) No, options desks run (usually proprietary) models whose job it is to price options and strategies along the curve in a self-consistent way (i.e. via no-arbitrage arguments) relative to some more liquid instrument like futures. OR on a bank exotics desk, they run custom models that try to price exotic products from first principles (monte-carlo simulations of cash flows, basically.) > (close to 6 digits a year) Way more expensive than this, the quants and developers who build these proprietary models are paid a lot of money. > Sure, you could get lucky once in a while but in the long run, not knowing the odds is going to hurt you and you are likely to lose all your money. This is both accurate and not, it depends what you are doing. I believe sophisticated retail traders can find mispricings, especially in less liquid products. If you are not looking at the vols and building curves, (or you don't know what that means), this is not you.

nealdotpy 6y ago
Glad someone rebutted. I'd like to add the person on the other side of a retail long options trade can be a market marker or people like me that sell to retail for the same reason. :)
scsilver 6y ago
What are vols and building curves? The factors that effect extrinsic values? Volitilty and time?
- caffeine 6y ago
  "Building a curve" means defining a function of where you think volatility should be as a function of strike and expiration. https://www.investopedia.com/articles/stock-analysis/081916/volatility-surface-explained.asp https://www.investopedia.com/articles/stock-analysis/081916/... It gets substantially more complicated, but that's a layman's explanation of what it actually is.

newleaf 6y ago

Just to add to your point which covers speculation, options can also serve as an insurance policy (hedge). Have a large exposure to the stock market and are not looking to sell? Buy puts and receive a payout if the market drops (simplified explanation, of course).