In Episode 8 of our Huge Options Blunders Series, we discuss the fatal error that many options traders make because they do not have a clear understanding of the risks of buying call options even if they are bullish on a stock.
View Video Transcriptokay so today’s video is the 8th in our
series that we’ve been titled huge
options trading blunders we decided to
produce this series for traders are
serious about trading options for a
living and badly want to succeed but
they keep getting sidetracked by
pursuing strategies with huge flaws in
them instead of taking the proper steps
to excel and improve as an options
trader
I’m the head trader SMB capital’s
options trading desk and I can tell you
for many years of experience that I’ve
seen every one of the mistakes that were
describing in these videos and some of
them I fell for myself when I first
started trading they’re 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
unnecessary detours in your trading
journey so if you’re committed to
trading full-time as an options trader
then I urge you to watch this video and
the rest of the videos in the 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 about
the actual truth and the rewards and
challenges of options trading and the
skills you’ll need to truly succeed we
want you to take a realistic path to
your trading goals which are attainable
if you’re serious and willing to put in
the work to succeed
[Music]
hi I’m Seth Freuburg 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 and in
our offices here in New York City I’d
like to suggest that you click on our
subscribe button right now so that you
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 eight in our series on
options misconceptions and huge mistakes
that you can make in your journey
towards becoming hopefully a full time
options trader and today’s lesson is one
of the most frustrating lessons for new
options traders because they’ll often
say analyze a stock or index brilliantly
properly pick the direction and
magnitude of a move time that move
perfectly and still manage to screw up
the options trade they made to express
their view on that particular stock ok
so the trade we’re going to describe in
this video involves buying a call in
other words going long a call so before
we get into the lesson let’s just review
the basics of what a call option is so
that there’s no confusion when I explain
how this strategy works so if you’re
already know how a call option works
don’t worry this will be quick and then
we’ll jump into the guts of the lesson
so what’s known as a call option on a
stock entitles the buyer of that option
to purchase 100 shares of that stock at
a certain price called the strike price
of that option regardless of what price
the stock is trading at before that
option expires the buyer of a call
option pays what’s called a premium to
the seller of the option because the
seller of that option is taking the risk
that the stock will go past the strike
price of the option in which case the
buyer can exercise his option but if the
stock on the expiration day of the
option is not beyond the strike price of
the option then the seller just pockets
the premium that he was given by the
buyer he walks away completely free of
any obligations the option in other
words expires worthless because it was
never triggered so let’s say
hypothetically that XYZ stock is trading
at 100 so let’s say that there’s an
options chain 30 days out from today for
XYZ and we
find that the option to buy XYZ for $105
in 30 days costs 80 cents then that
option would cost the buyer $80 because
because it represents the right to buy
100 shares of XYZ and so you need to pay
100 times 80 cents to buy the option
which is $80 now moving out 30 days.if
XYZ stock closes on the day the option
expires at 105 or less the option
expires worthless and the seller of the
option just pockets the $80 in the buyer
of the option just lost $80 on the
transaction however if the stock trades
up to say 107 then the seller is
required to sell to the buyer his shares
of XYZ company for $105 even though
they’re trading at 107 so in that case
the buyer would make a profit from
having bought the call because he paid
two dollars less per share for stock
than it’s actually worth and he paid 80
cents for that but that option so he
made out on that one so those are the
basic dynamics of a call option okay so
with that said options trading blunder
number eight starts out like a lot of
these trading blunders and that is with
what on the surface is a very logical
premise initially and that is that
buying a call is much cheaper and less
risky way of executing the bullish trade
then outright buying the 100 shares of
that stock in other words you commit
options trading blunder number 8 by
concluding that if I think a stock is
going up I’ll just buy a call it’s much
cheaper and it is true that calls are
much cheaper than buying the shares so
you’re probably wondering how this
premise could turn into a blunder well
it becomes a blunder very frequently
because many traders do not have a clear
picture of the nature of options and so
they think that the price of a call will
always go up if a stock rallies and the
price of a put will always go down if
the market sells off well unfortunately
it’s not that simple and today we’re
going to share with you a vivid example
to drive this point home so let’s take a
look at CMG stock Chipotle Mexican Grill
and we’ll see that back in November of
2019 it was trading up around 816 and
looking at this chart you you might have
been of the opinion that by
early next year CMG was gonna rally and
blast through its all-time high so let’s
say that you went out to the options
chain that was to expire in the first
week of the new year on January 3rd and
you’ll see that that 860 call which is
about 10 points above its all-time highs
was selling for six dollars and sixty
six cents which means you’ll have to pay
666 dollars to have the right to buy 100
shares of CMG stock at 860 in the first
week in January now this could be a very
attractive idea to you if you thought
that CMG had a really good chance of
getting to 700 by then let’s take a look
at the math on that to see why a trader
might be further lured into making this
straight so if CMG makes it to 900 by
January 3rd then if he shelled out
roughly 81 thousand dollars for 100
shares then he could sell them for 90
thousand dollars on January 3rd making a
10 point 2 percent return on his
investment if he’s right but if he buys
the 860 call he’d be buy the option for
666 dollars and then on January 3rd he’d
have the right to buy them for 860 when
they’re trading for 900 dollars so he
could buy the shares at 860 turn around
and sell them 1 second later for 900
dollars and make a $40 per share profit
immediately 100 100 shares which becomes
a gain of $4,000 in total which is over
a 500 percent gain the concept is
obviously very attractive on the surface
I wanted to let you know that there
really are sound viable long-term
techniques for trading options for
income and in fact we’re currently
running a to our free intensive workshop
at the moment where we’ll be teaching
you three of those strategies that real
professional options traders use
including a really simple but incredibly
effective technique 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% 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
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
don’t worry you won’t lose this video or
you can just head on over to options
class comm 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 okay so
we’ve gotten ourselves into this very
attractive trade where for the same
expected move we can make a 500% return
instead of a measly 10% and so we’re
feeling pretty good about ourselves so
we move forward to December 20th about
three weeks later and lo and behold CMG
has now rallied 18 points up to 835 and
so we were right CMG’s rally and so
we’re feeling pretty good about
ourselves but then we turn to the
options gene to find that not only
hasn’t the CMG call going up it’s
actually lost 60% of its value so the
stock is up 2.2% but the option is down
60% and you pound your hand on your desk
in frustration I mean your analysis was
perfect and CMG rallied and so the call
should have gone up right I mean calls
go up when stocks rally don’t they and
the reason that you’re confused is that
you don’t understand that options don’t
respond exactly like the asset from
which they’re derived because there are
other factors that affect an options
value and one of them is simple to
understand and that is simply that as
time goes by an option loses value
because of something called time decay
and that simply means that the longer
you go the closer you are to the options
expiring the less likely it is that the
stock can get up to the strike price of
your call you see in this example
there’s only 15 days to go until we get
to the expiration date which is January
3rd and so the option has to move up
another 26 points for that option to
have any value at all right because if
the stock is at 8:34 and the calls are
at 860 unless the stock gets up to 860
the option has no value at all an
expiration date I mean who’s going to
exercise their right to buy stock at 860
if the
stock is trading at less than 860 in the
open market so that write that call
option becomes worthless on that day and
it expires with no value and so with
only 15 days to go the market is
starting to devalue this option even
though CMG has rallied because the
option is running out of time to have
any value okay you say well still we’ve
got 15 days to go here so let’s just
hang on and let’s see what happens and
sure enough CMG rallies up to 865 on
expiration day five points past the
strike on the option and you start
high-fiving everybody and bragging that
not only did you call this one right CMG
exceeded your price target by five
points so you’re not only a technical
analysis genius you’re rich except then
you turn to your options change for CMG
and you realize that you lost money on
the trade that’s right you lost money
and I want you to understand why you see
the day that you were assigned this
shares and remember your call entitles
you to 100 of those shares you could
have flipped them immediately for 865
dollars per share having bought them for
860 per share so you would have made 500
dollars from selling those shares but
remember you paid 666 dollars for the
shares and so you actually lost money on
the transaction even though you were
right about everything so please don’t
fall for options blunder number eight
and this is not to say that buying calls
is a losing proposition in fact we have
traders on our desk who make a fortune
buying calls strategically at the right
time but those traders are fully aware
of the fact that the stock price must
exceed the strike price of the option by
at least the cost of the option itself
or you’ll lose money on the transaction
as you saw in this case with equities
it’s enough to be right about direction
with options if you don’t understand
them correctly and how they’re priced
you can get trapped into losing money
even if you got the direction the
magnitude of the direction and the
timing of the move right you need to be
educated about the nature of options
pricing to be able
take full advantage of the wonderful
opportunities that options do provide
the professional trader in many cases
now just to remind you as I said earlier
if you enjoyed this video and learned
something valuable from it 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 can just head on over to options
class com to register for this free
intensive workshop it really is 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 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 and all the other free trading
videos that were posting constantly on
our channel to help you to improve your
game as an options trader
* no relevant positions
