Today’s video continues our series on Options Trading Blunders and covers the fatal flaw in buying way out of the money, cheap calls on stocks. You’ll see a vivid example of the problems with this concept and how much money you’ll throw away by being lured into a program of buying cheap calls.
View Video Transcriptokay so today’s video is the third in
our series entitled huge options trading
blunders
we’ve decided to produce this series for
traders who are really serious about
trading options for a living and taking
the proper steps to excel as an options
trader as opposed to fooling around with
ridiculous trading ideas that don’t make
any sense when you examine them
carefully
I’m the head trader of SMB capital’s
options trading desk here in Manhattan
and I can tell you for many years of
experience that the pitfalls we’re gonna
be describing the in these videos are
real and if you’re serious about trading
for a living you really need to pay
close attention to these videos so that
you can avoid serious problems in your
trading journey so if you’re committed
to changing careers and trains ik
trading full-time as an options trader
then I urge you to watch this video and
the rest of the videos in this series so
that you don’t fall by the wayside like
so many aspiring traders who don’t want
to spend the time to learn the actual
truth about the challenges and rewards
of options trading
[Music]
hi I’m Seth Freiburg and I’m the head
trader of SMB capitals options trading
desk SMB capital is a proprietary
trading firm located in midtown
Manhattan and we provide capital for
options and equity traders from all over
the world trading both remotely in our
offices in here in New York City now I’d
like to suggest that you click on our
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don’t miss any of our free trading
videos that we produce for traders and
investors all over the world they’re
really very valuable ok so today we’re
going to be looking at options trading
blunder number 3 in our series on
options myths and huge mistakes that you
can make as an options trader so blunder
number 3 starts out with the fact that
people get lured into the idea that
options are a way to control 100 shares
of his stock for a lot less than the
price of the shares if you went out and
bought them outright for cash and it is
true that if you buy a call option at a
strike price above the market price of
that stock then you do have the right to
buy 100 shares of that stock at the
strike price of your call option and
regardless of how high that stock goes
so what that means is that the value of
that option can increase greatly The
Closer that the market price of the
stock gets to the strike price of the
option that you bought that part is true
so they then take that information and
they figure this hey if I don’t buy the
shares of the stock but instead if I
just buy a cheap call option then my
leverage is greatly increased and so my
returns will be greatly increased on my
trades because I can buy that call much
much cheaper than I can buy 100 shares
of stock and in fact here’s an example
of just such a situation which worked
out very well so let’s take a look at
Priceline back in the middle of 2017
when it was trading at 1810 so now let’s
take a look at the options which would
have expired on July 21st of that year
now if you move up the options chain way
above the market price of 1810 you’ll
see that 1950 call option expiring on
July 21st and you’ll see that it has a
price of four dollars and thirty five
cents well a call option gives you the
right to buy 100 shares of the stock so
you’d have to pay four dollars and
thirty five
times 100 or in other words $435 to buy
that call option now there was a
specific reason that we decided to buy
that particular strike in this example
and that’s because the option has what
is called a delta of about 10 which
statistically means that there’s about a
10% chance that the stock will be at or
above that strike price of 1950 on the
day that those options expire
incidentally most online brokers
automatically give you the Delta of each
option that you’re trading so you don’t
have to figure that out for yourself
it’s arrived at through a mathematical
formula that you don’t need to worry
about because your broker will calculate
it for you okay so anyway now you’re
thinking to yourself hey I’m a pretty
smart guy I mean I can control hundred
shares of Priceline stock for four
hundred thirty-five dollars instead of
having to shell out for 100 shares a
hundred eighty-one thousand dollars I
mean wouldn’t you rather plunk down four
hundred thirty-five dollars so that the
worse that gets for you is a loss of
just that for 35 if Priceline never
reaches my strike price of nineteen
fifty I mean you’d be crazy to buy the
shares for over a hundred eighty
thousand dollars if you could control
that same number of shares for $435
right and in fact let’s take a look at
what happened about a month later on the
day that the option is set to expire
well at this point Priceline had rallied
like crazy and the stock is now trading
at nineteen ninety eight so now the
strike price of the call option is
nineteen fifty and the stocks at
nineteen ninety eight forty eight points
higher than the strike price said the
option moments before it is expiring is
now worth about forty eight dollars
which happens to be more than ten times
the original price of the option so you
say to yourself you see I was right I
only had to shell out four hundred
thirty-five dollars when I got myself a
ten bagger my trade is worth ten times
what I paid for it well that’s an
amazing return I mean I should do this
every month and I’ll make a thousand
percent return on my money I mean if I
could just scrounge together ten
thousand bucks I could make a hundred
thousand dollars so I should just quit
my job and go out and buy ten Delta
calls every month and I’ll be rich right
so you’ll all open up your
and scream out options trading blunder
number three I made a thousand percent
return on a cheap out-of-the-money call
and every one of your neighbors will
look at you with envy and you’ll be just
rolling in it you just do this every
month and you’re set right well not
really
now before we explain why thinking in
this way leads to such blunders as an
options trader I wanted to let you know
that there really are in fact sound
techniques for trading options for
income and in fact we’re currently
running a – our free intensive workshop
at the moment where we’ll be teaching
you three of the strategies that real
professional options traders use
including a really simple but incredibly
effective strategy that some of the
greatest investors in the world like
Warren Buffett use all the time plus an
options trading strategy that has a
statistical 80 percent probability of
profit month in and month out plus an
option strategy that you can employ with
the stock that you like where you’ll
make your target profit whether the
stock goes up goes nowhere or even goes
down a small percentage so if those
strategies would be of interest to you
then you should check out the free
options place that we’re currently
running just go ahead and click the link
that should be appearing now at the top
right corner of your screen that will
open the free registration page in a new
window so don’t worry you won’t lose
this video or you can just head on over
to options class com to register for
this free intensive workshop it’s a rare
opportunity for retail traders and
investors to learn directly from Wall
Street traders but that’s exactly what
you’ll be getting through this free
online workshop so click the link to
sign up now and don’t miss it why does
this seemingly great thought to buy
cheap out-of-the-money calls
lead to options blunder number three
well it comes down to the statistical
basis of options trading remember I told
you that a 10 Delta option has
approximately a 10% probability of
expiring in-the-money
well the flip side of it is that it has
a 90% chance of expiring completely
worthless meaning you lose your entire
investment in that call 90% of the time
I want you to let that sink in in other
words essentially what happened on the
trade that I just showed you is a fluke
it will only happen one out of ten times
on average during the year I’m
priceline is in fact the stock that
moves around a lot but we’re talking
about a hundred eighty eight point rally
from when we first entered the trade
that’s not going to happen every month
in fact it’s hardly ever going to happen
remember there’s only one case where
this option expires with any value at
all and that is if the price line were
to get past nineteen fifty buy enough to
pay for the call that you bought which
if you do the math means the price line
would actually have to get to nineteen
fifty four for you to make any money at
all on the option I want you to really
think about that when we first put this
trade on Priceline was it eighteen ten
so even a price line rallied 140 points
the option will go to zero on expiration
day well Priceline doesn’t have to go up
it can go down they can hardly move it
can go up a mere 130 points anything
below 140 point rally and the option has
no value an expiration day because the
option to buy 100 shares at 1950
obviously has no value if the stock is
trading at less than 1950 and so the
option just dies with no value think of
it this way in only one of the five
cases does the option it do anything but
die worthless if the stock goes down a
lot goes down a little does it move it
all or rallies a lot but not a hundred
forty points even where it rallies a lot
the damn things still expires worthless
that’s how bad of a bet this is I mean
if every month you bought that $10 call
30 days from expiration like in the in
this example and waited for that big
upward move that you’d need to make that
option worth anything on expiration day
you’d be sorely disappointed because it
would not occur in almost any case
because I as I mentioned statistically
90% of the time that option will expire
worthless believe me it’s a tortuous
process to sit there and watch that call
lose value every day even by the way if
the stock is rallying because as every
day goes by time is running out that the
stock will actually reach the level of
your call in fact that stock could have
rallied four dollars every day for 36
days before the option expires and the
option still would have
expired worthless and so even though you
got the direction right and you bought a
call you still lost all of your money
that you have in the trade ok so just
think about that you would lose a
hundred percent of your investment in
the trade nine out of ten times I’d like
to meet the person who’s willing to sit
through that and actually go through
that experience eight nine ten months in
a row lose a hundred percent of your
initial investment in a trade in each of
those months I’d like to meet that guy
I’d shake his hand and to show you that
we’re not just talking theory here we
look back at the full 12-month period
which led up to that trade we ran the
twelve months prior to that trade in
Priceline starting with the August trade
from the year before so we could show
you twelve full months and you can see
the results the ten Delta call expired
worthless eleven times out of twelve in
the mid in the months leading up to the
wind we were just bragging about in July
of 2017 do you know anyone who would sit
there eleven months in a row waiting for
the big win in month twelve only a
little only to look back and realize the
whole campaign was a dismal failure and
you actually lost twenty four hundred
bucks even with that big win in the
numbers and it makes sense if you think
about it because the probabilities are
90% that you’ll lose on this trade so
you’ll lose almost all the time so to
make any money at all with this strategy
you’ve got to beat those kinds of odds
and so when you hear a guy bragging
about his thousand percent return on a
call option you’ve got to think about it
a little bit you’ve got to think about
the percentages the probabilities of
that actually occurring and realize that
it is miniscule and not worth their time
as a trader in almost all the months the
ten Delta call will expire worthless and
you will lose 100 percent of your
investment in that trade so by far out
of the money options is almost always a
losing proposition no matter how cheap
or attractive they might look on the
surface yes you’ll get an occasional
spectacular game but you’ve got to make
so much money on that one
just to break-even that the whole thing
is just about pointless so by now I hope
that you see why we say that buying way
out of the money call option
is a trading blunder it’s a highly
speculative strategy that’s basically
got the probabilities of a lottery
ticket and frankly they’re much better
more consistent and sound strategies
than going long some speculative a call
way out of the money because you happen
to have four hundred thirty five dollars
that you’re willing to blow so please
think about this don’t get lured into
these spectacular sounding returns when
in fact you’ll end up losing money if
you employ that same strategy
consistently stick with soundly designed
strategies that work consistently and
you’ll become a better trader long-term
that’s what the professional traders do
and that’s what you should do if you
want to trade options like a
professional now just to remind you as I
said earlier if you enjoyed this video
and learn something valuable from it and
would like to learn the details of three
real-world option strategies that
professional options traders use all the
time then you should check out the free
options class that we’re currently
running just go ahead and click the link
that should be appearing now at the top
right corner of your screen that will
open the free registration page in a new
window so you won’t lose this video
don’t worry
or you could just head on over to
options class comm to register for this
free intensive workshop it’s really a
rare opportunity for retail traders
investors to learn directly from Wall
Street traders but that’s exactly what
you’ll be getting through this free
online workshop so click the link now
and don’t miss it and please don’t
forget to click on the subscribe button
right now so you won’t miss the next
episode of huge options trading blunders
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* no relevant positions
