Options Trading As Easy As Trading Stocks (Episode 26)

Well, so my background is I was an options market maker, you know, so I was on the professional side of the business, you know, essentially making markets for, you know, both institutional and retail order flow. And one of my co-founders, he came from the institutional options, brokerage side of the business. And, you know, we've been kicking around this idea for a couple of years about, you know, the retail space and options. Then just as like a little bit of a background on how that looks retail options trading looks very different than institutional options trading. And when you see institutional options order flow, it tends to be multi-leg options. A lot of times it's against, you know, positions that they have at the, you know, hedge fund or institution or mutual fund. And whereas retail options order flow tends to be really speculative, really low probability in a lot of cases, you know, and it's essentially like the term is people, you know, lotto tickets or, you know, Yolo trading of the last year or two.

So, you know, we sat down and we started thinking about, you know, what is the issue? There's a couple of issues in retail options. Trading one is just simply, you know, people dive in and the things they understand very quickly are, you know, I think a stock's gonna go higher, so I'll buy a call or I think a stock's going to go lower and I'll buy a put. And that's, you know, one of the main entres into like, you know, for most people experiencing options on the retail level, but, you know, we looked at the products themselves and that it was actually, you know, nothing, there's been small innovation around the edges in the business, in this space and options are a massive part of retail brokerage. Like it's a, a lot of people, you know, have experience opening up a, you know, a brokerage account and then, you know, dabbling in options and what we were looking at, the products themselves and thinking, you know, there's problems in the products themselves that are pushing people into these low probability trades. And, you know, an example would be, you know, here's an expensive stock, like a Tesla or Amazon, I'm going to scroll the options chain to see a call that I can afford. right. I've

And so then what ends up happening unfortunately, is that's probably something that has a 10% probability of profit, whereas, you know, the way an institution would, or an experienced option, straighter would approach something like that is, they'd say, you know, I don't think that Amazon is going to go up 25% in the next month. You know, why would I ever own a call that's 20% out of the money. And therefore they would look at it more strategically and say, you know, but Amazon could go up 8% on this earnings report. How do I position myself for that happening? And how do I limit and define my risk in case I'm wrong? And that's sort of the first level of like kind of advanced options trading, which is, you know, really trading around a plan with defined risk and not buying the improbable setting up for the more probable right.

Yeah. Well there's a couple of ways and that's sort of the third level of people's experience into options. Hopefully if they've made it through that part of the journey is options also allow you to position against something happening. So for instance, if you know, right now in a, you know, if people are looking around at stocks in the market that they think are, have been oversold in the sell off, you know, there's ways to essentially say, you know, I'm going to position, I'm gonna sell a credit, put spread below where the stock is trading. And if this market does not follow through down another 20%, I collect that premium and you'll hear this term in options trading called like income trading. And that means a couple of things, but one of them is an example like that, where you're essentially positioning against something happening. And when you do that, you have a higher than 50% probability of profit on those positions.

And then the other way that someone could, you know, sort of use options within a more, you know, buy low sell high type strategy is when you are long stocks and long a portfolio, you know, you can sell call spreads for instance, to the upside of where the stock is trading. And a lot of times, you know, a good mentality is basically, you know, I would lighten up on my positions up there anyway, right? So I might sell some of my, you know, stocks or my holdings if the market rallied up until this point. And so you can position and add income potentially to, you know, a long stock or a long stock portfolio by selling calls and selling call spreads. And again, this is if the stock just goes sideways, I collect that premium from those options.

Well, you see in the market itself, you see everything, right? So you see that speculation and that's essentially people using options for leverage, right? And so they're essentially saying, oh, you know, I'm a buyer of this stock, you know, how can I position in options so that, you know, I'm only risking X amount of dollars rather than tenfold that amount. And so that's one, you know, particular way to do that. Now, if I would say, you know, options are not for everyone. And you know, it takes some learning around, you know, like how they work. There's a lot more variables in an option than there is on a stock, essentially you are. I always tell the, um, you know, like sort of the metaphor is if you see odds of a horse race before the horse race starts and you know, there's an 80 to one shot and a favorite and you know, all of those things, what the options market is or derivatives in general is that it's a live market all the way up until the last second of that rates.

And those odds are changing the entire way. Right? Mm-hmm and I think that's a good way for people to think of options is they are diminishing asset that has a timeframe, right. Which is very different than just buying a stock when you buy a stock and it goes down, you can, hopefully it comes back. At some point you can wait it out with options. They are, you know, you have, if you have a two month expiration, you know, that's your two months for something to happen or not happen. And so I think a great, you know, going back to that conversation about potential income and things like that, you know, if you have, if you're just sort of an investor and you are, you have no interest in any sort of speculative options trading, there are opportunities there to add income to those portfolios. And it's sort of, you know, if you're comfortable with that and comfortable sort of actively watching those things because they, you know, you, can't just sort of set 'em and forget them. Right. And check back in on your portfolio in six months, you kind of have to pay attention to what's going on. If you're comfortable with that, then that's opportunity out there that you wouldn't, you know, have otherwise, you know, like a market that's going sideways or a bear market there's opportunity within options to sort of trade around your portfolio.

Yeah. So I think there's a couple of examples. So, you know, we all, we're human, right? And we make really bad decisions under stress. right. In our portfolios, we panic, we sell low when we, you know, didn't need to, we get euphoric at highs, you know, like all of those things. And I think options are really good in a couple of different ways. One is the simple, you know, sort of like hedging strategies, right? So this is the type of mentality where, you know, let's say you wanna be a buy low, sell high type I investor, but that's very difficult. Right? And especially under times of stress, there are ways that you can hedge portfolios and hedge, you know, let's say you feel you're a little overweight in one stock. Like let's say it's like Tesla and you it's keeping you up at night because it's so crazy.

You know, you could say I'm willing, I'm a long term holder believer in a Tesla. That's not a recommendation. I'm just saying, it's an example, that lot of crazy stock that a lot of people own Uhhuh. Well, you know, you could do options. You could do put spreads and things like that. That basically allow you to sleep at night and avoid those bad decisions at Lowe's. Right. And the same thing on the upside, you know, instead of just having to make a decision to sell a stock because you feel like you're getting a little overweight and maybe that stock's getting extended, you know, you could do those strategies that I was, you know, referring to earlier about like selling calls and selling call spreads against those holdings. And if the stock went up through those levels, then you already were a seller up there, but you don't have to make that decision that day. You're just sort of putting it 10% higher in the stock. And if it happens, it happens and you would've been thrilled to sell up there anyway, if it doesn't happen, then you've gained that income of essentially selling to something, you know, positioning against something happening.

I think it's a little of both and I, I really go back to that. The psychology of, you know, I was a professional trader and one of the, I think the greatest skills you can have as a professional trader or an investor is sort of recognizing your own cognitive biases, right? And you're constantly checking yourself. You're saying, you know, you see patterns where there are no patterns. There's, you know, all kinds of mistakes that you're, this brain of ours can make. And these are ways to sort of have a plan and that income, you know, that's money out there in the options market. The options market is really efficient and a lot of other people are using it incorrectly. And a lot of other people are using it in the opposite way that you might want to. And so if you are long a portfolio of stocks, there's income upside of those stocks available within the options market.

And then the same thing with the sort of hedging strategies that, you know, I would consider those, how much am I willing to pay to be able to sleep at night and not make bad decisions in volatile markets. Right. And so I would look at 'em both ways. I think the income thing is something everyone should, you know, if they're interested in that sort of thing, they should explore the hedging is, you know, I think a very good long term strategy, if you are the type of person that can get affected by, you know, for instance, this current market. I mean, if you were long an Amazon and you just watched it go down 25%, but you're like, I never want to sell Amazon in my life. Then, you know, the options you can say, well, I'm willing to give up 3% in Amazon so that I can hold it for the next 25%. Right. Or whatever it is. And so I would say both ways and now, you know, an ideal situation is you're doing both right. You're selling upside for income and that's allowing you to pay for protection on the downside.

And an ideal options portfolio. I mean, there are no ideal anything, but what I would say, you know, when people ask me, you know, what should this look like? There's two ways to go wrong in options. One is to have really high probability that, you know, essentially that nothing could ever happen. And we call that like picking up pennies off the train track yeah. Essentially like if you look at your options portfolio and you're at 95% probability of profit, that's not a good position because the one thing that goes wrong is you're risking too much to make too little. Right. And the flip side of that is obviously if you look at your options portfolio and you have a 10% probability, that is a Yolo portfolio of options and , it's the way that to die by a thousand cuts over time.

It's interesting is what's happened in the last month or so, or six weeks. I think we've been selling off, right? Like the overall broader markets. But man, if you were paying closer attention, like going back to the fall, when those, you know, sort of pandemic names and all started collapsing, all those pelotons and zooms and things like that, there has been some pain out there that wasn't making the front page of the paper yet. Right. And you know, that was really like the sort of initial signs of this sell off. And then finally the broader market sort of caught up with it and now we're in a spot. Right. And everybody's assuming some sort of recession everybody, you know, that those sorts of things, we know it ends at some point. Right. But we have been spoiled. Most of the sell-offs have been very quick, right. Over the last decade. Really. They've been real quick and they've recovered. Right. And so the, by the dip, you know, mentality, this one feels slightly different. It's longer, it's drawn out. It's almost boring. The selloff in some ways, you know, it's going, the market's going down like 3% or 2% a day. We're not seeing that huge crash so that I think we've been accustomed to where you're like, okay, now I can buy

It was like, yeah, you blinked. And it was already recovered, which was, you know, in hindsight, a little crazy. Yeah. So from an options perspective, what happens is, you know, you'll see this on TV and then in financial press and things like that, everybody talks about the VX and the VX, you know, people refer to it as the fear gauge and everything. There's some things that are true about that. But from an options trading perspective, what it essentially means is options are pricing in an uncertainty. And right now the VIX has been consistently 30 ish, you know, for the last few weeks. And what that means is options are expensive. And what that means for investors and traders is, you know, you basically need the market to follow through in one direction, if you are buying options right. This day to day, you know, like Friday was up and Monday was down.

If you are long calls and puts, you're really not getting that opportunity for that follow through for that, you know, call put to really be effective. So from an investor in trading standpoint, you have to realize how expensive these options are. And you know, those things I was mentioning earlier about credit spreads and essentially, you know, positioning outside of this range, that's the way I would be looking at this market. I think it's, unless you saw that sort of classic capitulation where, you know, the market was down 10%, you know, on the day, and then it snapped back and things like that, you know, I would be trading this fairly conservatively from an option standpoint and I would be trying to keep those options trades at a probability of profit of slightly above 50%, you know? And that's like, again, are those sorts of, I wouldn't be rushing out to buy puts, I guess is my point.

Okay. But you could be doing put spreads and you could be saying, well, what I wanna protect against really is the, like another 25% down from here, right. I can survive a 10% more of this selloff, but 25, percent's gonna put me in a really bad place where I have to make really, you know, difficult decisions. And those are the sorts of things where, you know, if Amazon, for instance, is I think it's right around, it's just above 2000 right now. And if that was a long term holding, then it's not that like, I wanna protect if Amazon goes to 2000, cuz I think you should be with that. It's that I wanna protect if Amazon goes to 1600 or something on a huge, you know, like capitulation crash and things like that. And then if you position for that, what it allows you to do is ideally you're sitting on a little bit of cash.

You know, what it allows you to do is then if Amazon were to do that, then you could be a buyer of the stock down there, you know, instead of a seller of the stock because you need that, you know, you're terrified. And so those are the sorts of things where it's like, it's sort of like playing for, you know, singles and doubles and all, and not going crazy into this options market right now, because things are already sort of priced that way. They're already assuming lots of, you know, of this sell off continuing, essentially,

Yeah. And that's, you know, again, like sort of going back to the origin story of options, AI is, you know, we didn't feel like that those kinds of nudges and that ease to do those types of trades, you know, like multi-leg trades, we didn't feel like that was the products out. There were sort of encouraging this. You know, I just wanna buy a bunch of these calls cuz I'm euphoric or I wanna buy a bunch of these puts at the lows because I'm terrified, you know, those sorts of things. And you know, we took a view of, you know, if you made this visual, you know, the way most equity traders, think of markets and think of stock charts and this stock has sold off a bunch, you know, like we've made it highly visual. And so you can see this call spread or you can see this credit put spread on that stock chart, really understand what your risk reward is all defined risk. You know, we don't allow on the platform for somebody just to, you know, sell a bunch of puts, right? Because we want that math to be very easy for people to understand so that they can make these, you know, better decisions or at least it's in front of them and it's easier to access so that they can hopefully make better decisions.

Yeah. And so you can go to options, ai.com and read about the platform and you know, see videos and GS and all of how it works. And I think most people's reaction when they first see it is like, whoa, that looks really different than my current platform. And then what we also have there's links there. We have a couple of things. We have free tools that we publish. And you know, for instance, we do an earnings calendar where it shows how options are pricing, the expected moves for all of those earnings as these companies report. You know, so for instance, home Depot and lows, and I think a bunch of those companies are reporting this week and it'll show you what the options market is pricing and then what that stock did on its last few earnings. And that's a great gut check for an investor that owns those stocks or for somebody that's already, you know, trading options to sort of set their expectations of what the market is pricing. And then on top of that, we have, you know, a blog and content called learn options. AI that are, is linked from there where I write a lot more about, you know, some of these things we spoke about and you know, how these strategies anywhere from a call to an iron condo works and trying to translate it into, you know, plain English essentially.

Yeah. Thanks so much for having me