Huge Options Trading Blunders: I made 1000% return on an out of the money call! (episode 3)

okay 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 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 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 and all the other free trading videos that were constantly posting on our channel to help you improve your game as an options trader that's our goal

Channel: SMB Capital

Views: 75,648

Rating: 4.744627 out of 5

Keywords: out of the money calls, out of the money calls strategy, out of the money call option, out of the money call option strategy, out of the money call spread, call option expires out of the money, call option strategy, options strategies call options

Id: FhUcZZB3tmU

Length: 14min 4sec (844 seconds)

Published: Wed Jan 29 2020