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Long Long time ago there were 2
option traders. One consistently lost while the other made lots
of money.
"Why are you so successful?" asked the loser Mr Chasing Hope, to
the winner Mr.
Bookmaker "Why do I lose almost every time?" Bookmaker
explained, "to win in any game, you must know the rules, you
must know what motivates the players and you must have an edge.
I will teach you these simple things so you can be a winner."
IN THE OPTIONS GAME THERE ARE
ONLY TWO BETS
"The option game consists of only
2 bets. One bet is a
call while the other is a
put. A player
buys a call if he thinks the market is going up while he buys a
put if he thinks the market is going down. The person who takes
the other side of the bet is the seller of the option."
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"Option sellers do business in the way of insurance companies.
An insurance company charges a
premium for fire insurance. The
insurance company only pays if your house burns down. If it does
not burn down the insurance company keeps the premium."
"You buy a
call if you think the market is going up. If it stays
the same or goes down the option seller keeps the premium."
"You buy a
put if you think the market is going down. If it
stays the same or goes up the option seller keeps the premium."
"In both examples your odds of winning are only one in three if
you buy an option."
"It gets even worse for the buyer. Think of health insurance. If
a person has cancer, smokes, drinks and works in a high risk job
such as construction do you think the insurance company will
charge him a low premium? Of course not, the premium will be
very high to compensate for the added risk of illness accident
or death. Even if this poor soul dies it is of no concern for
the insurance company. The premiums collected from all high risk
clients such as this man will more than compensate for any of
these individuals dying. The same is true for markets. Call and
put options for the Japanese Yen are very expensive. In fact the
market can move in your favor and you may only break even or
lose money. The reason is simple. The yen is highly volatile and
the option seller must charge a high premium to protect himself
against adverse price movement."
"As a Options Buyer, you may be correct in market direction and
still lose money."
"Observe the prices for December 2000 options. The 950 call is
sold for 20 points or 2000 RM. That means that the price of the
December Futures must go to 970 for the call buyer to break
even. The 700 put is sold at 35 points or 3500 RM. That means
that the December Future must fall to 665 for the put buyer to
break even."
The call buyer would lose all his
money if price closed at 950 on Dec 29 the expiration of the
December futures contract.
These are theoretical premiums as options have not yet been
launched on KLSE futures. Once they are launched premiums will
probably be even higher.
"Are you beginning to understand? To make a profit, you must be
correct in market direction and price has to make a major move
in that direction No wonder 80% of option buyers lose money."
WHO ARE THE PLAYERS AND WHAT
MOTIVATES THEM?
Bookmaker explained, "There are
two groups of players in options. The buyers and the sellers.
You, my friend Hope Chaser, are a buyer. That is why you lose
consistently. You buy and you hope the market moves in your
favor. You play options like a buyer of social welfare lottery
tickets. You buy hope. Have you ever known anyone who
consistently makes money buying lottery tickets? The only
consistent winner is the underwriter. For every dollar taken in
only 60% is paid out."
"The seller of options uses the same tactics as a lottery
underwriter, insurance company or casino."
"These businesses assess risk, levy a premium, and get rich."
"Their edge can be your edge. You as an option seller will win
80% of the time."
TRADE WITH AN 80%+ CHANCE OF
MAKING MONEY ON EVERY TRADE !
Bookmaker was always happy to
share his knowledge. His mission in life was to earn consistent
profits from the market and teach a few worthy souls his
moneymaking strategy.
"Chasing Hope, why do you buy calls and puts when most of the
time you lose?"
Hope answered "I buy them because I have hope to make huge
profit with only small premium risk."
Bookmaker made his usual frank comment, "Most of the time you
lose your premium don't you. Better you should sell hope than
buy it?"
This leads to Bookmaker's Rule
#1: NEVER BE A BUYER OF AN OPTION, BE A SELLER
because it is a proven, statistical fact that 80 % of options
expire worthless. If you buy an option your chances of winning
are only 20 %. If you are a seller of an option your odds of
winning are 80 %.
"This sounds like a winner, how
do I sell options and how do I protect myself should the market
go against me? I am afraid to be a seller of options because the
brochure from my brokers said that sellers of options have
unlimited risk," asked Chasing Hope.
Bookmaker replied, "options are like anything for sale. Buyers
and sellers come together in a marketplace and decide on a
price. The process to be implemented is similar to buying a
share or futures contract. Buyers and sellers are matched
electronically. In US options markets buyers and sellers are
matched using an open outcry system. Risk is managed by having a
pre existing plan to cut losses should your position go against
you. Here is a simple plan you can use."
"This plan puts time on your
side. An option seller put money into his pocket every day."
"If January soybeans settled between 550 and 475 by expiry. the
seller would collect 22 cents for the 550 call and 10 cents for
the 475 put. This would be a profit of 1600 US$ as each cent in
grains = 50 US."
"To protect yourself from
unlimited loss you would place a protective buy stop at 550 and
a protective sell stop at 475. If the future price reached those
levels you would immediately liquidate the entire position. You
would take a loss on one option and a profit on the other option
as well as a small profit on the futures. There is less than a
20% chance of this happening."
This was Bookmakers Rule #2:
USE THE SAME WINNING PLAN AS CASINOS, PUT TIME ON YOUR SIDE.
The bookmaker explained: "casinos
are in the hope and dream business. They sell the dream that you
can make $2,000,000 by investing only one dollar in the one arm
bandit. Have you ever seen anyone win a jackpot? Usually what
happens, a player will start with a few hundred dollars and lose
all. The player keeps pulling the handle hoping that the next
pull will be a big jackpot. Time is the enemy of the player
because the longer he plays the more money he loses The result
is empty pockets. Time is on the side of the casino."
"In
options trading, time is on the side of the option seller.
Each day that passes the option becomes worth less."
"Here, my friend Hope, is an example of an option selling plan
with Live Cattle. Live Cattle which is traded on the Chicago
Mercantile Exchange is an excellent market for an option seller.
Most of the time Live Cattle congests in a range. You may sell
both puts and calls at the same time."
"By selling the 70 call and 65
put you would take in a premium of 2.85. Since live cattle is
400 US$ for each cent that would mean you collect 1140US$ of
premium."
"If price remained between 65 and 70 until expiry of the
December contract, you would earn the entire premium."
"Do not forget to manage your risk. Remember what the broker
brochure said. Sellers of options have unlimited risk."
"Set a Mental Stop to liquidate
your Options Position. Never let a Options to get In The Money "
This is Bookmaker's most
important rule, RULE #3: IF YOU SELL AN OPTION, Never let
your Options get In The Money unless you place a buy or sell
stop on the actual Futures Contract.
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