I think I have a serious issue with buying stock options. This post is not to brag about what a great trader I am and it’s not going to tell you which stocks will make you rich.
I saw a positive risk opportunity in the world, and I took it.
In doing so I realized there’s an extremely fine line between buying stocks, and going down to Vegas and putting your life savings on red. Spend enough time on r/WallstreetBets and you will read story after story of people losing every penny they have, after being up hundreds of thousands.
I realized that IF I am going to play this game, I need to not only become technically good at buying and selling options, but I need to develop a set of guidelines that will prevent me from gambling.
How To Actually Buy & Sell Options
I lost a couple of grand before I figured this part out, if you get nothing else out of this article this part will hopefully save you a lot of money.
First, sign up for a Robinhood account. (Use that link & you’ll get a free random stock when you join.)
There are two basic kinds of options, a “Call” and a “Put”. Buying a Call means you think the value of a stock is going to go up. Buying a Put means you think the value of a stock is going to go down. Simple right?
Here’s the trick.
If stock A is worth $5, and in one week you think it will be worth $10, don’t buy a $5 Call that expires in a week.
A stock option has “theta” which is basically the rate of value decline over time. Your stock loses value over time, exponentially. So if in one week stock A is only worth $6, you actually lost money even though it went up 20%.
If you have a target “sell by” date, I like to buy an options contract MUCH further away. So if I think stock A will hit $10 in a week, I buy a $5 Call for 2-3 months out.
This way, if the stock goes DOWN, I now haven’t lost 100% of my money. If the stock only goes up 10-20%, I am now up 20-40% instead of break even. If the stock hits my $10 mark, I’m up 100%-200%.
I learned this lesson painfully. This is how new traders can easily lose 99% of their portfolio.
Only Gamble On Positive Risk
By definition, investing is gambling. Playing games of chance for money.
Lots of things in life are gambling. Starting a new business. Marrying your wife. Getting a college education. All of these are “investments” with a percentage chance of having a return that is more than you put in.
So what exactly is the difference between buying stocks/options, and going down to Vegas and letting it all ride on red?
In a casino, the house always wins. The entire system is set up so that more often than not, the house will make money. This means the longer you play, the more bets you make, the more likely you are to lose money.
A casino has negative risk. You are more likely to lose, than you are to win.
This is the key difference between gambling at a casino and investing in stocks or starting a business. When you buy stocks or start a company, there is the potential to have positive risk, or the ability to be more likely to win than to lose.
Positive Risk: a 60% chance to win, and double your money.
Negative Risk: a 40% chance to win, and double your money.
At the end of the day almost every kind of investment is a roll of the dice. Even buying US savings bonds, there’s some percent chance that the US government collapses tomorrow and you lose every penny.
The way to become a good investor, in my opinion, is to be able to figure out which stocks and options pose highly positive risk. If there’s a 75% chance to 3x your money? That’s an amazing place to put your money, even if you lose and it goes to $0.
You make that same bet 10 times with $10,000, and you are up $110,000+.
The real trick comes from deeply understanding the stocks that you are buying, and what causes them to go up or down.
Never Gamble More Than You Are Willing To Lose
Duh Koby, I know.
Let me say it again.
Never gamble more than you are willing to lose. Don’t be an idiot. It doesn’t matter if you think there’s a 90% chance of success and 10x’ing your money. Don’t place every penny you have on that bet. Don’t bet more money than you are willing to lose.
Don’t put all your money on one stock. Don’t put all of your resources into one business.
Assume you are going to lose the money you spend. Be happy when you don’t. But go into the investment assuming it’s gone.
If this business fails, I’ll be okay. If this stock goes to $0, I’ll be okay. If my wife leaves me because I was a dumbass on Robinhood and takes 50% of whatever I have left, I’ll be okay.
The thing about positive risk, is that you can still lose.
Whatever can happen, will eventually happen. If the goal of making bets on positive risk is to keep doing it over and over and over, it means that very frequently you WILL lose. Even if you win more times than you lose, you will eventually lose.
Understand that you will still lose. Often. Never gamble more than you are willing to lose.
Diversify Your Bets
This is advice that is as old as time for a reason.
Never gamble more than you are willing to lose, and don’t put all of your eggs in one basket.
You might say to me, “Koby, it’s okay if I lose 100% of my money, it’s only $10k and I can make it back.” You might think you have a killer opportunity to buy stocks or start a business with high positive risk.
Diversify your bets as much as you possibly can. Make LOTS of bets with high positive risk. Don’t just take the money you are willing to lose and make a couple of investments that you think will have a return.
The best investors in the world make LOTS of bets, in a number of different opportunities that have positive risk.
You don’t 10x your money by making 1 investment with a 100% return. You do it by making 10-100 investments that you lose some, but you win more.
If you keep making 2-3 bets, you are bound to lose huge chunks of your money, even if you win more often than not. It doesn’t matter if it’s on Robinhood or in business or in anything else in life.
Except if you’re married. Just cross your fingers and close your eyes on that one.
My last example of positive risk, use this link and go sign up for Robinhood. You have a 0% chance of losing money, and a 100% chance of getting a free stock worth up to $500. 😉