Most people I talk to think stock trading is gambling and for that
reason, they distance themselves from it. Objectively speaking, it is a
good concept. When we gamble, we have little or no control over the game and
the House always has an edge in term of winning probability. However, it
puzzles me when I see the same people saying stock trading is gambling
but they show up frequently in casino playing Black Jack or feeding the
“Tiger Machine” quarters after quarters.
I made my first stock trade in 1995 and knew little about the
market. I simply wanted to get my feet wet and to feel the excitement of
stock trading. My main strategy was “buy and hold” Later on, it became
“buy, hold and hope” and then eventually “buy, hold, hope and pray” I
might not realize it but I was gambling back then. I had 50/50 chance of
winning and had little or no control over the game.
Visualize ourselves on a Black Jack table in a casino. We have a 21
hand and find out the House has a Black Jack hand. Can we say to the
House please let us keep our bet and our 21 hand, the House then gives up
its Black Jack hand and let’s play another game so we will have a better
chance of winning? I am sure they will look at us like we are aliens from
another planet who don’t know how to play Black Jack on Planet Earth.
Believe it or not, we can do that in option trading to buy more time and
postpone our loss until the market condition works in our favor. Sound
impossible? Let’s look at one trade I actually made.
To avoid misunderstand of recommending stock,
I use ABC as the stock symbol in this trade.
March 20, 2014: ABC stock was trading above $25/share. I sold April
24.50 short put for $0.60/share.
April 3, 2014: ABC stock was trading barely above $24/share. My
April 24.50 short put position was in-the-money and it was a losing trade
at that moment. To avoid loss, I rolled my April 24.50 short put to May
24.00 short put for a net credit of $0.14/share. I basically tell the
market I have a losing position but I don’t want to pay for it now. Give
me another chance for my losing position to bounce back. Though it does not always
happen but in this case, I collected an extra $0.14/share for “postponing
my debt payment” and getting better terms for my “debt”.
The rolling gave me more time for my short put position to work.
Best of all, I collected an extra $0.14/share credit and created $0.50
extra cushion in the rolling process. With my original April 24.50 short
put trade, ABC stock has to close above $24.50 for my trade to be
profitable. After the adjustments, ABC stock only needs to close above
$24.00 for me to collect my profit. For those who follow my option
lessons posted on our school website, this rolling should be easy to
May 5, 2014: ABC stock was up and traded above $24/share. I bought
back my May 24 short put for $0.33/share, closing my position altogether and
recognizing a net profit of $0.41/share.
Let’s take a closer look at the trade:
My original selling of April 24.50 short put on March 20 gives me
roughly 9% per month Return On Capital (ROC) if
the stock closed above $24.50/share on April 19, 2014. Please notice the
ROC percentage varies with different stocks. For this particular stock,
it yields 9% ROC. That was my plan A. However, if adjustments are needed
and the trade drags on for, let say, 3 months, I still make roughly 3%
per month ROC, not bad for plan B. Good luck doing that with the bank Certified Deposit Account. I have control over my ROC.
I closed the trade on May 5, 2014 for a net profit of $0.41/share,
a roughly 6.7% ROC in 45 days from March 20 to May 5, not bad for a trade
that didn’t even go as planned on the first try. Good luck doing that on
Black Jack table. I have control
over the length of my trade.
I pick ABC stock which is an Exchanged Traded Fund (ETF) to avoid
earning surprise quarterly and to make my rolling easier if needed. I
have control over avoiding earning cycle altogether.
I pick ABC stock since it is very liquid with $0.50 strike price
increments and penny wide bid and ask option price which is an ideal
scenario for option trader. I have control over the stock liquidity.
Apparently, I have full control over my trade. With that control, I
make the Probability of Profit (POP) works in my favor.
I frequently went to Las
Vegas for my investment conferences and seminars
during my stock and option learning process. I never stopped by casino to
play Black Jack during those visits. Knowing I am playing a game I have
full control and an edge of POP, why bother playing Black Jack, a game I
have little or no control and the House has an edge?
Investing or gambling? you decide!