Stock Options: Gambling or Investing?
In a gathering of friends there was this conversation between Charlie and Pete:
“Hey Pete, you live in Las Vegas, do you go to casinos and gamble often?”
“No, not at all. I never go to casinos to gamble. I don’t need to, I’m already gambling in the largest casino in the world”.
“Yeah? Which casino is that?”
“The stock market”
“That’s not gambling, Pete. That’s investing.”
“Charlie, for you it’s investing, for me it’s gambling. You see, I’m a stock speculator and as such, I bet on the direction a stock price will go. In my situation, this is just plain and simple gambling. I buy stocks for the sole purpose of generating a profit if/when the stock price goes up in value, hopefully within a short period of time. I do not hold stocks for a long time. I bet that the stock I choose will go up fairly quickly and I will then dispose of it for a profit. If the stock does not go in the direction I predicted or even stays flat or its price starts to drop in a given period I will rid myself of the stock and take a loss if I must.”
“Pete, that’s just like betting on a casino gambling table. Why not just go to one of the casinos in Vegas, since you live there anyhow, and place your bet there? You don’t have to wait days to see the results like you would in buying a stock for speculation. In minutes you know if you’ve won or lost”.
“Totally different Charlie. In a gambling table you are totally betting on chance or entirely dependent on pure luck. You have no data to work with to improve your odds of winning. The odds are fixed in favor of the house. In the stock market I can do a lot of research on stocks and figure out which ones I think will go up in price. There are many factors that can guide me in deciding which stock to bet on and which ones to avoid. I can look at a company’s financial reports, balance sheets, past market performance, dividend records, ownership composition, market trends, market price highs and lows, plus almost an endless amount of statistics on a particular company. None of these data are available on a casino table”
“Yes, that is correct Pete, but there is still no guarantee that with all the data you have on hand you will always correctly find the right stock to bet on. As you know there are hundreds of high paid stock analysts and experts who do nothing but study the dozens of statistics to do the same thing you are trying to do. Yet most of them fail in selecting the right stock all the time. There is, in fact, a group of people who call themselves ‘stock pickers’ who make this their livelihood. They call their websites ‘advisory services’ and the service they offer is picking stocks for investors and speculators.
Charlie continues: “If I were you I would not bet on stocks if I’m a speculator. I’d bet on options instead. Just like stocks, ETFs, and Indexes, you can use options to gamble or play it safe in the stock market. Here is where you could make real money gambling in the stock market. Of course, you don't always win gambling in options, but more often than not, and if you're savvy enough, your winnings could be much bigger than your losing bets.
In my case, I choose the safer approach by using options to complement my stock positions. Options enable me to increase my rates of return on stock ownership, reduce risk and increase my dividend payouts.
But if you really wish to speculate or gamble in the stock market, options trading would be the way to go”.
“Look at this scenario, Pete. Let’s say on June 29 you strongly feel that Advance Micro Devices Inc. (AMD) is poised for a nice uptick from what you have gleaned in your statistical research. The stock is currently priced at $12.84 and you decide to buy 800 shares for a total investment (or gambling bet) of $10,272. Assuming you were correct in your prediction and nearly a month later, on July 25th, the stock price has risen to $14.08. You decide to sell, close your position and pocket a net profit of $992. This is a very attractive return of 9.7 percent on your original investment (or bet) in just a short period of time.”
“But Pete, look at what you would have achieved if you did options instead of the stock. On June 29 you could have bought the AMD September 14 call option (expiring in the third week of September) at a price of $1.05. On July 25th when the stock was priced at $14.08, the AMD September 14 call was priced at $1.45. The AMD September call option has appreciated 38 percent, from $1.05 to $1.45, while AMD stock went up by only 9.7 percent in the same time period.
157% Versus 2.7% Profit?
“Here is a more dramatic example. On June 28 JPMorgan Chase (JPM) stock was priced at $89.16. On the same date, the JPM July 92 call option was priced at $0.47. The stock was on a strong upward trend since June 23 and looked well on its way toward higher prices. So let’s assume you entered the stock on June 28 and bought at $89.16. Let’s assume further that I’m a speculator (gambler) like you but I’m an options gambler and bought the JPM July 92 call at 47 cents. Two days later, on June 30th the stock price had risen to $91.58 making a 2.7% price advance. On the same date of June 30, my call option price rose to an astounding $1.21 for a percentage increase of 257%! In this situation, I would have liquidated my option position and pocketed a 157% profit on my initial bet while your stock was only 2.7% up on your initial bet. And this happened in only two days time.”
The numbers are quite amazing!!
“See the big advantage of trading options instead of stocks? There is really a lot more to this comparison than what I’m presenting to you. I just wanted you to see what options can do for you whether you are a speculator or investor like me.
“Okay, Charlie. You have shown me how stock options can be a better vehicle to use for speculating in the stock market. How do you use options in your stock investment?”
“I use the covered option selling strategy to complement my stock investments. Rather than go into a long explanation of how options work wonders for me it is better for you to start learning options by reading everything on this subject.
You will see how stock options are a remarkable tool for increasing returns on stock ownership as well as learn how to use options by itself as an investment instrument. The numbers are quite amazing.
© 2018 Daniel Mollat