In this episode of our continuing series on huge options trading blunders, we discuss a completely insane idea that sounds totally reasonable on the surface to beginner options traders who don’t know better. We show a vivid example of how foolish this idea is.
View Video Transcriptokay so today’s video is the fifth in
our series that we’ve entitled huge
options trading blunders we decided to
produce this series for traders who are
really serious about trading options for
a living and badly want to succeed but
they keep getting sidetracked by dopey
ideas with huge flaws in them instead of
taking the proper steps to excel as an
options trader
I’m the head trader of SMB capitals
options trading desk and I can tell you
from many years of experience that I’ve
seen that every one of the mistakes that
we’re going to be describing in these
videos 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 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 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 rewards and challenges
of the 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 the work in
to succeed
[Music]
hi I’m Seth Freuburg and I’m the head
trader of SMB capitalist 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 now
I’d like to suggest that you click on
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they’re really very valuable ok so today
we’re going to be looking at options
trading blunder number 5 in our series
on options misconceptions and huge
mistakes that you can make as an option
trader so blunder number 5 starts out as
most of these blunders do with a true
statement that unfortunately has a
hidden downside that you need to think
through but most people don’t and that
statement is this the market won’t go
down forever it will eventually bounce
no matter how bad things get and
historically that’s of course true even
in the depths of the Great Recession of
2008 and 2009 the market did eventually
bounce in fact it did so in March of
2009 and the current bull market has
pretty much remained intact ever since
with a few short-lived Corrections in
the mix now in order to explain how this
leads to an options trading blunder I
need to make sure you’re familiar with
the basics of how index options work if
you know something about options don’t
worry this will be quick and then we’ll
jump into the core of the lesson now
almost all of you are probably familiar
with equity options where call buys you
the right to buy 100 shares of a stock
at the strike price of that option any
time before the option expires and a put
option entitles you to sell 100 shares
at the strike price of the put before
that option expires but there are also
index options which works similarly to
equity options except there’s no such
thing as 100 shares of an index like the
S&P; 500 you can’t really buy or sell 100
shares of an index but what you can do
is get paid cash $100 per point if the
index expires before the strike price of
an index call that you buy or
alternatively you’d be paid $100 per
point for
point the index drops below the strike
price of your index foot so for example
if an index is trading at 1400 and you
buy the 1410 call if the index goes to
say 1415 you’d receive $500 in your
account if the index closes at 1410 or
lower your call expires worthless on the
other side of the ledger if you buy a
1385 put and the market sells off to
1375 you’d make $1,000 but if the market
just sold off to 13 85 or higher the put
would expire worthless so those are the
basics of index options and remember you
can buy options but your broker will
also allow you to sell options and your
broker will allow you to put together
combinations of options in other words
options strategies that involve both
long and short options purchased in a
way that is that I’ve been Tages to you
as a trader okay so now armed with that
knowledge let’s talk about this idea
which some option traders have which
seems so amazing on the surface yet it’s
so incredibly insane and dangerous once
you start digging into it a little bit
deeper so let’s drill down a little bit
deeper about the fallacy that we’re
highlighting in today’s lesson and we
can do that through a vivid example from
the real world that could have taken
place very easily in the past one of
many examples that I could have shown
you today ok so let’s go back to August
17 2015 now on that day let’s suppose
you said to yourself hey I think I’d
like to pull about 3000 dollars out of
the market over the next 12 days because
Valentine’s Day is coming up and I need
the money or for whatever reason so you
figure well I know something about index
options so let’s see on that day the
sp500 was trading it around 2100 so if I
go in and sell 10 of the 2040 puts
expiring in 12 days and the market
closes at or above 2040 in 12 days then
I walk away with 3000 $450 why because
the option sells for 3 dollars and 45
cents but the option obligates you to
pay $100 for each point below 2040 if
the market sells also you multiply that
price by 100 and since you sold 10 of
them you
collect a total of three thousand four
hundred fifty dollars now if the market
closes above twenty fourty then you have
no obligation to pay anything because
the deal was that you’d have to pay $100
for each option for each point below
twenty forty so any closing price of SPX
above that means that the option expires
with no value no obligation on your part
and you just walk away with three
thousand four hundred fifty dollars so
that was your Valentine’s Day plan now
because of the risk that you’re taking
on with these ten puts your broker is
actually going to require you to have
two hundred fifty five thousand dollars
in your account to make sure that if
there’s a really big move down in the
market you could be obligated to come up
with a large amount of money to pay for
your obligations for those ten puts and
that money needs to be in your account
now in options trading there’s a concept
called Delta and it’s defined in
different ways but it roughly equates to
the probability that you’ll actually
have to pay off on options that you sold
so if an option has a delta of twenty
then there’s a 20% chance that the
option would expire in the money which
would be a bad thing because then you’d
have to pay off on the option you sold
as opposed to just walking away with the
money that you got for selling the
options you don’t have to figure it out
on your own incidentally every major
options broker will tell you the Delta
of any option for you on their platform
so anyway let’s say your system which
would be a very common system let’s say
that your system is that every time the
Delta of your option gets up to 20 then
you’ll buy back that put and roll it
down to an option on that same options
chain that is now a 10 Delta option
which is safer and farther away from the
market and because at that point you’ll
almost always be down money on the trade
then you’ll have to sell more options in
order to be able to make money on the
trade at the end of the day so at this
point you might think well hey if the
market sells off that’s okay I’ll just
roll my options down to a lower strike
and sell enough options at the new
strike to still be able to make money on
the trade right so I mean I really can’t
lose ultimately can I
I just keep rolling down till I win
right I mean the market will eventually
bounce right
always does in other words you’ll get
lured into options blunder number five
which says I’ll always win eventually if
I keep rolling my short puts down right
and this is a very common belief among
beginner option traders now before we
explain why this idea which seems so
logical on the surface is actually
completely and utterly insane and will
never work I wanted to let you know that
there really are sound techniques for
trading options for income and in fact
we’re currently running a – our free
intensive workshop 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 could employ
with a stock that you like where you’ll
make your target profit whether the
stock goes up goes nowhere or even goes
down as a small percentage so if those
strategies would be of interest to you
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 the
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
so let’s get back to our example so we
sold those 10 puts at twenty forty
twelve days out from the expiration and
now let’s move forward to August 20th
now on that day the market opened up
down sharply most traders will wait till
about 10:30 to make moves on their
options income trades and so in this
case the 2040 options had actually moved
up to 41 deltas which makes sense now
that the markets of 2050 to the 2040
options we sold are only 12 points away
with nine days to expire so shouldn’t be
surprising that the chances of those
expiring in-the-money have now risen to
41% so with our protocol once we get
into the area of 20 or higher we have to
roll the options down to closer to the
10 Delta options at that time so let’s
take a look at what happens next it’s
important to understand this
so our protocol dictates that we must
buy back to 2040 puts well those have
really increased in price because now
they’re so close to the market so the
ones selling them is now taking on a
huge amount of risk if there’s a 41%
chance that they’ll have to pay off and
so to close those short positions and
buy those back is going to be very
expensive and in this case it’s $16.25
but remember you only sold those for 3
dollars and 45 cents so to roll your
puts is gonna cost you a lot of money so
now you’ll see that we’ve rolled down
but we also increased our size to 35 put
options now it’s crucial for you to
understand why we had to increase to 35
put options so remember we originally
received three thousand four hundred
fifty dollars for the 2040 puts well to
close them and roll them down we’re
gonna need to pay sixteen thousand two
hundred fifty dollars now if we roll
down to the ten Delta options at the
1975 strike you’ll see that they’re
priced at three dollars and ninety five
cents so even to get back up to about
just one thousand dollars of cash flow
you need to buy thirty-five of them
because much less than that and you
don’t even overcome the deficit from the
first roll well now the market would
have to drop a lot to hit those 1975
puts but still you’ve taken on the risk
now of thirty-five foots so now your
broker is it going to require a ton more
capital from you and in fact you’ll need
over eight hundred nineteen thousand
dollars of capital to roll down and
we’ve just gotten started so yes it’s
possible to sell enough puts to have
positive cash flow but it requires a lot
more capital than the original trade now
let’s move forward to the next day
you’ll see that the SPX is now sold off
again this time down to 2015
so that has pushed our 1975 puts to 27
Delta’s so it’s time for us to roll
those down again 50 points
19:25 strikes which are a hundred
fifteen points below our original
strikes so now let’s take a look at why
we had to sell 75 of those well remember
the deficit from the first roll was
twelve eight but we brought back in
thirteen thousand eight twenty five from
selling the thirty-five puts but now to
buy those back as the market has sold
off so dramatically we will need to pay
twelve dollars and fifteen cents and
we’ve got 35 of them to buy back this
time so it will cost us forty two
thousand dollars to buy those back and
roll them down and now it will take us
seventy five options at the nineteen
twenty five strike to make up all of
that loss from the previous rolls and
still be able to eke out about a
thousand dollars from the trade but now
that we’re selling seventy five options
our broker is going to require us to
have in our account over 1 million six
hundred sixteen thousand dollars because
of the much larger risk of this trade so
by now I think you may already have
figured out where this is going and I
won’t go into as much detail on every
roll but just quickly at the end of that
same day August 21st we had to roll
again and this time we had to roll down
to the eighteen hundred strike and sell
two hundred eighteen puts just the turn
our cashflow positive again because at
that point we were down a hundred fifty
four thousand dollars on this trade and
now our capital requirement has
skyrocketed to over four million dollars
three days later the market tubes again
and now we’re down three hundred
fourteen thousand dollars and we’re
forced to roll down yet again but this
time we have to sell that’s right
365 puts to get to barely positive cash
flow and now our capital requirements
have ballooned to six and a half million
dollars so let’s just summarize to show
you how unseen this guy we started out
with ten puts and a capital requirement
of two hundred fifty five thousand
dollars and by the time we’re done we
were selling three hundred sixty five
foots and our broker was requiring us to
put up over six and a half million
dollars in our account to cover our risk
now that was the
roll and at the end of the day you would
have in fact made money on the trade the
market did bounce at that point and the
trade would have actually been very
slightly profitable when the options
expired but that’s obviously not the
point the real point should by now be
fairly obvious you started out with a
nice idea to buy your wife or girlfriend
some jewelry on Valentine’s Day and you
end up before the final roll downs three
hundred fourteen thousand dollars on the
trade and having to put up six and a
half million dollars just the more or
less breakeven on the trade now why
don’t you close your eyes and just
imagine the slow-motion train wreck of
this trade even if you did have a spare
six and a half million dollars lying
around do you think you would have
exposed it to this trade when you were
down three hundred fourteen thousand
dollars and had to sell three hundred
sixty-five puts just to put yourself
into a position to basically break even
on the trade will allow me to bring you
into the real world
no one has no emotions and no one has an
infinite amount of capital and even if
you did I have never met the person who
would just keep digging a deeper and
deeper hole for himself even though it’s
an undeniable fact that if you threw
enough capital this trade you’d always
eventually make a little bit of money
but you’re human and you do have
emotions and you certainly don’t have
unlimited capital and so one point you
would cry uncle because you wouldn’t be
able to take the risk and the pressure
of this trade if you can’t intuit that
from this presentation then just take my
word for it you would have bailed out at
some point in this process and taken a
huge loss so please do yourself a favor
and do not ever get trapped into the
thinking of options blunder number five
I’ll always win eventually if I keep
rolling my short puts down right the
irony is that it’s an absolutely true
statement but it’s utterly an insane and
impossible to tolerate in the real world
not the fantasy world of no emotions and
unlimited capital professional traders
would never fall into this trap and you
shouldn’t as well 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
often 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 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 one more thing 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 we’re
posting constantly on our channel to
help you to improve your game as an
options trader
* no relevant positions
